What's the Latest on Currency Fluctuations?

After decades of being valued at far less than the U.S. dollar, the Canadian dollar began dramatically appreciating in value during 2007, and finally reached par with the U.S. dollar on September 20, 2007. It then soared as high as (US) $1.10 before dropping back in March 2008 to about (US) $0.97. This has made a lot of Canadians proud, but it doesn't change the fact that, on average, Americans earn about 20 percent more than Canadians do. Retail prices are still higher in Canada than they are in the U.S., so Canadians haven't benefited much on that front either. For example, the Asics 2120 running shoe is $94.99 in the U.S. and $159.99 in Canada. The Canon Powershot A5701S camera is $199.99 in the U.S. and $249.99 in Canada. A 2007 BMO Capital Markets report showed that overall, prices are 24% lower in the U.S. than they are in Canada. Pressure is now being put on Canadian retailers to drop their prices because of the loonie's increased value compared to the U.S. dollar, and some changes are starting to occur. For example, Sears Canada has cut the price of a 32-inch Samsung LCD TV from $1199.99 to $999.99.

The rise of the Canadian dollar has been caused many factors, including a high level of mergers and acquisitions in Canada, large U.S. budget deficits, lower interest rates in the U.S. than in Canada, problems in the U.S. economy, and the strength of the Canadian economy. But oil is perhaps the key factor. The Canadian dollar is likely to remain near parity with the U.S. dollar for the foreseeable future because the price of oil is likely to stay high (it reached $110 a barrel in March 2008), and Canadian production of oil from the tar sands is steadily increasing.

In the Opening Case in Chapter 18 of Business, 6th Canadian edition, the point is made that when the Canadian dollar rises some businesses benefit and some are hurt. Listed below are some specific examples of Canadian companies that have been hurt as a result of the appreciation in our dollar:

• Ottawa–based Lee Valley Tool, a manufacturer of fine woodworking tools, sells about half its output to U.S. customers. Leonard Lee, the company's founder, says if the Canadian dollar continues to appreciate in value, the company may have to go out of business because U.S. customers are not willing to pay dramatically higher prices for the company's products.
• Sherbrooke, Quebec–based furniture maker Shermag Inc. closed four of its eight plants in 2007 and cut 320 jobs because demand for its furniture in the U.S. has declined. The company had a 51 percent drop in export sales between 2006 and 2007.
• Plessiville, Quebec–based Carbotech International makes sawmill machinery for firms in the lumber business. The high loonie has caused its export sales to decline, and the lumber companies it sells its products to have also had problems with exports. Jean-Paul Bergeron, the CEO of Carbotech, noted that there is still demand for the custom-made machinery the company makes because foreign manufacturers like China cannot supply such products.
• Windsor, Ontario–based Cunningham Sheet Metal—which fabricates products like railings, furniture, and canopies—has survived the rise in the Canadian dollar by concentrating on the high-quality niche market for its products. But if other companies start doing the same thing (because they have lost customers in the declining automobile manufacturing industry), further problems will develop for the company.
• Senior managers at Martinrea International Inc., a manufacturer of auto parts, say that their company can no longer compete in the export market for auto parts because of the appreciation in the Canadian dollar.
• Mississauga, Ontario–based Amtex Manufacturing is also concerned about the high Canadian dollar, but to date it has not been too negatively affected because it focuses on a high-end niche market where buyers are willing to pay higher prices. The company has actually been helped to some extent by the rise in the Canadian dollar because it now can buy raw materials cheaper than it used to.
• Canadian oil and gas companies don't like a high Canadian dollar because their revenues come in U.S. dollars but their expenses come in Canadian dollars. So, when the Canadian dollar increases in value, the value of the U.S. dollars they receive for it is relatively less than it was when the Canadian dollar was lower in value. For example, a (US) $80 barrel of oil in 2008 is worth the same as a (US) $52 barrel of oil in 2002 (when the Canadian dollar was worth (US) $0.65). The high Canadian dollar is also discouraging U.S. investment in Canada (although some Canadian nationalists wouldn't see this as a bad thing). Since 65% of Canada's oil and 55% of Canada's natural gas is exported to the U.S., this is a significant issue. One of the outcomes of the higher Canadian dollar is a pullback in activity in the oil and gas business.

What can Canadian companies do to cope with the rapid rise in the value of the Canadian dollar? Canadian manufacturers can no longer get by with low productivity as they could when the Canadian dollar was low. They need to buy productivity-enhancing machinery (which can now be purchased at a lower price than formerly because of the higher value of the Canadian dollar). But Canadian capital investment per worker continues to lag behind the U.S. and the OECD average.

If companies focus on improving productivity, they can cope with the new, higher value Canadian dollar. Mike Keilhauer, a veteran furniture manufacturer, says his company is now doing as much business as it did in 2000, even though it is using only half the space it formerly needed, and has only 60 percent of the employees it formerly had. The company has also focused on reducing manufacturing, shipping, and inventory costs.

It's not just Canadians that have to cope with the uncertainties caused by fluctuating currencies. European companies that do business with the U.S. are having the same kinds of problems that Canadian firms are having because the euro has also risen in value against the U.S. dollar. Consider the case of Airbus, a European manufacturer of commercial airplanes. If the U.S. dollar falls, say, 10 cents against the euro, Airbus loses a billion euros in foreign exchange because the majority of the company's expenses are in euros, but its aircraft are sold in U.S. dollars (this is the same problem that Canadian oil and gas companies are faced with).

The decline of the U.S. dollar has resulted in some rather notable symbolic changes around the world. For example, India has announced that visitors to the Taj Mahal will now have to pay in Indian rupees, not U.S. dollars. Iran, Venezuela, and Russia now demand payment for their oil in euros, not U.S. dollars. And rapper Jay-Z is shown flashing a wad of euros, not dollars, in his latest video. While most U.S. citizens will not be too happy with these developments, the decline in the value of the U.S. dollar has benefited U.S. exporters because their products are now relatively cheaper in Canada and Europe. In fact, in 2007 U.S. exports increased by 12.4 percent over 2006. Just as Canadian exporters benefited when the Canadian dollar was lower than the U.S. dollar, now U.S. exporters will see an increase in their business.

The decline in the value of the U.S. dollar has also affected other countries, particularly those that peg their currency to the value of the U.S. dollar. In Saudi Arabia, for example, the riyal has been pegged to the U.S. dollar since 1986. Saudi Arabia has typically followed trends in U.S. interest rates. But when the U.S. Federal Reserve cut interest rates in the U.S. in the fall of 2007, Saudi Arabia didn't want to follow suit because that would increase inflation rates in Saudi Arabia (the rate was already at 4 percent, up from 0.3 percent in 2003). In May 2007, Kuwait unpegged its currency from the U.S. because it was also concerned about inflation.

The recent fluctuations in Canadian and foreign currencies raise many questions about the world currency system in general and about the Canadian dollar in particular. Where is the Canadian dollar headed in the future? What about the U.S. dollar? Will it continue to decline in value as the rest of the world becomes increasingly concerned about economic problems in the U.S.? Given the increasing impact of globalization, do national currencies even make sense anymore? Is there some way that businesses can avoid the risk of fluctuating currencies?

Some financial experts are calling for rather dramatic action to reduce the uncertainty caused by currency fluctuations. One solution that has been proposed is to have just three world currency zones: the dollar, the euro, and the yen (for North America, Europe, and Asia, respectively). Stephen Jarislowsky, a renowned Canadian money manager says that Canada should either replace its dollar with a new North American currency (patterned after the euro) or it should peg the Canadian dollar to the U.S. dollar to reduce dollar gyrations. While life would be simpler with one North American currency because there would be no exchange rate risk, the Canadian government opposes this idea because it fears Canada's sovereignty would be threatened and the government would give up its right to control inflation and interest rates.

Questions for Discussion

1. Several factors have caused the Canadian dollar to rise in value against the U.S. dollar (for example, lower interest rates in the U.S. than in Canada). Explain how each of the factors mentioned above have influenced the upward movement of the Canadian dollar.
2. Have Canadian professional sports team been helped or hurt by the rise in the Canadian dollar? Explain.
3. Consider the following statement: "The Canadian dollar is going to stay close to par with the U.S. dollar for the foreseeable future because oil prices are going to stay very high and Canada exports a lot of oil to the U.S." Do you agree or disagree with this statement. Explain your answer.
4. Explain how increasing productivity will help Canadian companies cope with a higher Canadian dollar.

Sources: Alia McMullen, "Softening Dollar Offers U.S. Exporters Some Hope," The National Post, January 3, 2008, www.nationalpost.com/story-printer.html?id=211694; "Adapt or Perish," The National Post, January 2, 2008, www.nationalpost.com/story-printer.html?id=209540; Kate Jaimet, "Loonie Squeezes Iconic Tool Maker," The National Post, December 24, 2007, www.nationalpost.com/story-printer.html?id=194940; David Blanks, "Lack of Access," The National Post, November 29, 2007, www.nationalpost.com/story-printer.html?id=130590; Gwynne Dyer, "Countries Begin to Say Farewell to Greenback," Winnipeg Free Press, November 28, 2007, p. A15; Scott Deveau, "Airbus Sales Can't Stop Tailspin," The National Post, November 23, 2007, pp. FP1, FP3; Steven Chase, "Consider a Continental Currency, Jarislowsky Says," The Globe and Mail, November 23, 2007, p. B3; Zena Olijnyk, "Retail: Dollar Daze," Canadian Business, November 19, 2007, www.canadianbusiness.com/shared/print.jsp?content=20071119_198707_198707&; Rachel Puffer, "Design'07 (Furniture): The Chair Man," Canadian Business, November 19, 2007, www.canadianbusiness.com/shared/print.jsp?content=20071119_198704_198704&; Robin Banerjee, "The Petroloonie," The National Post, November 15, 2007, p. FP19; Greg Keenan, "Loonie has Parts Makers Reeling," The Globe and Mail, November 15, 2007, p. B14; Jeff D. Opdyke and Jane J. Kim, "Dollar Daze: Investing With a Weak Currency," The Wall Street Journal, September 26, 2007, pp. D1, D4; Jacqueline Thorpe, "Liftoff a Long Time Coming," The National Post, September 22, 2007, pp. FP1-FP2; Nathan VanderKlippe, "Prices Lag Dollar's 'Moonshot'", The National Post, September 22, 2007, p. FP4; David Berman, "Currency Not Alone in Rise Against U.S. Dollar," The National Post, September 21, 2007, pp. FP1, FP3; Steven Chase, "Parity. So What?" The Globe and Mail, September 21, 2007, pp. A1, A5; Claudia Cattaneo, "High Dollar a Cash Drain on Oilpatch," The National Post, September 21, 2007, p. FP3; Joanna Slater, "Falling Dollar Squeezes U.S. Trade Partners," The Wall Street Journal, September 21, 2007, pp. C1, C9; Micahel M. Phillips, "World Economy in Flux as America Downshifts," The Wall Street Journal, September 20, 2007, pp. A1, A11.

Answers to Questions for Discussion

1. Several factors have caused the Canadian dollar to rise in value against the U.S. dollar (for example, lower interest rates in the U.S. than in Canada). Explain how each of the factors mentioned above have influenced the upward movement of the Canadian dollar.

   The factors mentioned are large U.S. budget deficits, lower interest rates in the U.S. than in Canada, problems in the U.S. economy, the strength of the Canadian economy, the price of oil, and merger and acquisition activity in Canada. Illustrative answers are provided here for two of the most important factors: interest rates and the price of oil.

   Lower interest rates in the U.S. than in Canada mean that U.S. investors are more likely to invest their money in Canada because they can earn a greater return on their money. To invest in Canada, they need to buy Canadian dollars. This increases the demand for Canadian dollars, so the value of the Canadian dollar rises.

   As far as the price of oil is concerned, remember that Canada now provides more oil to the U.S. than any other country in the world, including Saudi Arabia. As the tar sands oil output continues to increase, more and more oil will be exported to the U.S. and it will become increasingly dependent on Canadian oil. In order to buy all that oil, U.S. purchasers have to use Canadian dollars. So, once again, the increased demand for Canadian dollars will cause the value of the Canadian dollar to increase.

   In explaining these and other factors, student need to understand that the causes of currency fluctuations are complex and therefore difficult to predict, and that there is often an emotional element at work in currency fluctuations. For example, in the fall of 2007, the Canadian dollar surged to (US)$1.10. Most analysts argued that there were no solid economic factors that would support such a high Canadian dollar, and indeed, the Canadian dollar soon dropped back to par with the U.S. dollar.

2. Have Canadian professional sports team been helped or hurt by the rise in the Canadian dollar? Explain.

   Canadian professional sports teams have been helped by the rise in the Canadian dollar because player salaries are paid in U.S. dollars, but team revenues are generated in Canadian dollars. As the Canadian dollar rises, in effect, player salary expenses decline because the team has to pay out fewer and fewer Canadian dollars to get an equivalent number of U.S. dollars. These differences are dramatic, because the Canadian dollar has risen so far from its low of $0.62 (US) in 2002. Remind students of the statistic presented in the opening case of Chapter 18 of the text: A team with a payroll of (US) $30 million in 2002 would have had to pay over $46 million in Canadian dollars then, but only $33 million in 2006 (and, of course, only $30 million today). Also remind students that the situation could get better (if the Canadian dollar rises even further) or worse (if the Canadian dollar declines against the U.S. dollar).

3. Consider the following statement: "The Canadian dollar is going to stay close to par with the U.S. dollar for the foreseeable future because oil prices are going to stay very high and Canada exports a lot of oil to the U.S." Do you agree or disagree with this statement. Explain your answer.

   Answers will vary, but most students may agree with the statement because there has been much publicity about the price of oil. But they must be able to explain why the combination of these two things will tend to push the Canadian dollar higher (see the answer to question #1 above). Students who disagree with the statement may make several arguments: that there is no simple relationship between the price of oil and the value of the Canadian dollar, or that the price of oil will decline if the world goes into a recession, or that tar sands oil output will never be significant enough to really affect the value of the Canadian dollar. Any one of these arguments could be true, but student answers should state the likelihood of each of these outcomes occurring.

4. Explain how increasing productivity will help Canadian companies cope with a higher Canadian dollar.

   The issue of productivity is discussed in several different places in the text, and the example provided on p. 43 will be easily understood by students. We can apply the basic ideas contained in that example to the practical problem raised in this question.

   If a Canadian company can reduce the number of workers (or the number of hours worked) that are needed to produce one unit of output, obviously its productivity will rise because it is getting more output for the same amount of input. This, in turn, will allow the company increased flexibility in various aspects of its operations. It could, for example, keep the price of its products the same and generate more profit for its shareholders. Or (in a period where the Canadian dollar is rising in value), it could reduce the prices of its products so that the price of its products to U.S. buyers would not increase and U.S. buyers would therefore continue to buy the company's products. In that case, the Canadian company's profits would not increase, but it would still be selling the same volume of products that it sold before the Canadian dollar rose in value. In general, a company should always be trying to increase productivity so that it is more able to cope with the impact of various environmental events such as increased competition or changes in exchange rates.