United States Dollar Compared to the Canadian Dollar

Modon 1

The Rise in Value of the “Loonie”: United States Dollar Compared to the Canadian Dollar

Michael Modon1 October 14, 2007

Abstract

This article analyzes the change in the United States dollar-Canadian dollar exchange rate of 2007 and the increasing value of the Canadian dollar compared to its American currency counterpart. Macroeconomic theory is used to help explain the correlation between the United States’ trade deficit with Canada and how this deficit affects a nation’s gross domestic product (GDP).

1 Junior, The University of Akron; Finance, Economics Major; Expected graduation: May 2010 Modon 2

Introduction

Many Americans cross the northern boarder every year to experience life in Canada.

Popular Canadian tourist cities such as Toronto, Vancouver, and Windsor are heavily populated with Americans anxious to spend luxury money in these international cities. Now, Americans are beginning to realize that their own currency, the “all-mighty dollar,” is not so mighty compared to the Canadian dollar anymore. Nicknamed the “loonie” because of the loon on the dollar coin, the

Canadian dollar, with respect to its American counterpart, has experienced a dramatic increase in strength over the past few years. Many Americans are shocked to hear this; nobody would believe that the Canadian dollar has accumulated so much power. In January 2002, the Canadian dollar was only worth 61.79 cents in United States dollars terms (“$1 Cdn = $1 US”). To their surprise, today the exchange rate floats near a perfect 1:1 ratio. To further examine the shift that has taken place over the past few years, economic principles and concepts can be studied to understand this change.

While much of the exchange-rate focus has been on the increasing value in the euro compared to the dollar, many people forget about the differences between Dollar and the “loonie”.

Figure 1 represents the actual United States Dollar-Canadian Dollar exchange rate. At the end of

2002, $1 of American money was worth $1.60 in Canadian currency. (“U.S. Dollar”) Since that peak, there has been a consistent decline for the next four years, all the way to where the dollars have hit parity – indicating that the 1:1 ratio exists. This decline in value of the American dollar, while magnified and greatly affected since 2003, is unlike the changes occurring during the

1990s. Michael Holden, a member of the Parliamentary Research Branch of the Canadian government states the three major factors to influence the exchange rate as “the difference between Canadian and U.S. inflation rates; interest rate differentials between the two countries; and the world price of commodities.” (“Canada” 1) Holden uses the concept of inflation to explain that the falling value of the U.S. dollar is partly because the American currency has been overvalued in recent years, “and the current decline represents a return to equilibrium levels.” Modon 3

(Holden 2) Because of the inflation in the United States that took place in the 1990s, the U.S

Dollar is finally “catching up” to the increase in inflation.

Karl Pinno and Apostolos Serletis, authors of “Long Swings in the Canadian Dollar,” claim that this decrease is part of a larger devaluation. According to these economists, three major swings in the U.S. Dollar-Canadian dollar exchange rate have occurred since 1973. Prior to

2003, the Canadian exchange rate has seen “24.83% depreciation from 7 January 1992 to 14

February 2003.”2 (Pinno) Contrary to this huge jump that has occurred between 2003 and 2007,

Pinno and Serletis comment that all of these swings have been gradual. However, the value of the Canadian dollar has increased by nearly 33% in the last four years. To examine this phenomenon, macroeconomic theory of international trade must be applied.

Figure 1: Canadian Dollar to U.S. Dollar Exchange Rate

Economic Model

On an aggregate level, the United States has various elements that affect its Gross

Domestic Product (GDP). The equation reads:

Y = C + I + G + X – IM where Y stands for a nation’s GDP level, C is the value of consumption expenditures, I is the amount of investment expenditures, G is the expenditures of the government, X represents the

2 From January 1973 to February 1986 the Canadian exchange rate (in United States dollars/Canadian dollar) experienced 30.76% depreciation. From February 1986 to January 1992 the Canadian exchange rate experienced 26.04% appreciation. (Pinno) Modon 4 amount of exports of a nation, and IM signifies the value of a country’s imports (Krugman 166)3.

Many Americans are familiar with the concept of “trade deficit,” particularly because it has become a budgeting issue of the United States government. Mathematically speaking, the trade deficit is represented by X – IM. Because the United States imports more goods than exports them, the trade deficit actually decreases the overall GDP of the country every year, and in turn, lowers the percentage of economic growth year over year. Controversially, Canada operates their budget at an overall trade surplus, indicating that their GDP actually grows every year due to international trade. Because the U.S. government is in such good standing with its neighbor to the north, the deficit of Canadian imports and exports greatly contributes to the overall trade imbalance. Michael Holden explains that the trade deficit affects the United States because of its significance to overall GDP. In 1997, the trade deficit accounted for 2% of the country’s GDP.

Now, the current deficit is around 5% of the United States GDP. (Holden 2) This indicates that there is a general outflow of capital from the United States, which puts pressure on the dollar.

International trade can be further examined to determine how supply and demand of foreign goods in the open market affects exchange rates. United States demand for Canadian goods continues to increase over the years; therefore, the demand for the Canadian currency has increased as well. Graphically speaking, the demand curve for the Canadian “loonie” is shifted to the right on a standard supply-and-demand graph. As a result, the quantity of Canadian dollars consumed increases, but the U.S. must pay the price by having the American dollar depreciate in terms of the Canadian dollar, indicating that the currency has become less valuable in terms of

Canadian money (Krugman 470). Likewise, the Canadian currency has appreciated in value in terms of the American dollar, because Canadian consumers’ demand for American products has decreased. Canada operates at a trade surplus with the United States. This shifts the demand curve for American dollars to the left, indicating that the Canadian dollar becomes more valuable in terms of the American currency.

3 Krugman explains the alternative method of calculating GDP. The equation reads Y = C + S + T. C represents consumer expenditures, S is the amount of savings, and T is the amount in taxes paid to the government. Modon 5

To further examine the trade deficit between the United States and Canada over the last

Figure 2 four years, the United States Source: U.S. Census Bureau of Foreign Trade Census Bureau’s Foreign Trade

division has collected monthly

data displaying the value of

exports and imports to Canada.

By studying the data, one can see

that every month since January

2003 has resulted in the United

States exporting more than

Figure 3 importing goods in relationship to

Canada. This signifies that every

month since 2003, the United

States has operated at a trade

deficit with the Canadians. These

monthly deficits range from about

$4 billion in 2003 to nearly $8

billion in 2006 (“Foreign Trade

Statistics”).4 Currently, most of the 2007 monthly values are in the $5 billion region. Figure 2 displays the values of monthly imports and exports to and from Canada since 2003, and Figure 3 shows the monthly deficit, in millions of dollars. For exact figures, please see Table 1 at the end of this document, as well as a cumulative chart of the trade deficit.

Part of the reason why it has taken so long for the United States to become affected by the trade deficit in terms of currency value is due the exchange rate pass-through elasticity. José

Campa and Linda Goldberg, economists associated with the Federal Reserve Bank of New York,

4 The highest monthly trade deficit occurred in October 2005, with an overall deficit of $8.98 billion. During that month, the United States imported $27,725 million in Canadian goods, and exported only $18,746 million. (“Foreign Trade Statistics”) Modon 6 conducted a study to correlate a country’s trade patterns with its fluctuation in exchange rates.

By calculating elasticities to measure this exchange rate volatility, Campa and Goldberg calculated the elasticity of the United States dollar to be .23 in the short run and .42 in the long run.5 (Campa 682) Given the concept of elasticity, this indicates that exchange rates revolving around the U.S. dollar do not change very rapidly. This correlates to the authors’ thesis, by claiming, “Countries with higher rates of exchange rate volatility have higher pass-though elasticities, although macroeconomic variables have played a minor role in the evolution of pass though elasticities over time.” (Campa 679) The U.S. is not one of the countries that have experienced statistically significant declines from the trade deficit. In addition to Campa and

Goldberg’s declaration, Joseph Gagnon and Jane Ihrig, published scholars in the International

Journal of Finance and Economics, support the theory that trade price elasticity is a factor of the volatility in exchange rates. They state, “Trade price elasticities in aggregate data are generally estimated around or somewhat below unity; a range of 0.5 to 1 appears reasonable... [H]igher elasticities imply more impact of exchange rates on activity.” (Gagnon 318) Because the United

States dollar’s elasticities are so low, the volatility in the dollar is very minimal.

World commodity prices also greatly affect the value of the United States dollar in relation to the “loonie.” In the overall international market, many commodities are trading at all-time highs. Notable goods that are trading at record-high values are oil, gold copper, and wheat. In

September 2007, a barrel of oil traded at a record $83.32. Gold prices were at a 27-year high at

$740 an ounce (“$1 Cdn = $1 US”). Because Canada exhibits an overall trade surplus, a rise in these prices allows the country to increase the value of exports compared to imports, thus driving their GDP level higher. In contrast, the United States, because it operates at a significant trade deficit, experiences the increase in world commodity prices as a factor to decrease the GDP.

Prices of imports and exports are higher; however, because the country imports so much more than it exports, the increase in world prices increase the trade deficit even more, lowering the

GDP. Nonetheless, the percentage of the deficit that accounts for GDP increases as well.

5 The elasticity values for the Canadian dollar are .75 in the short run and .65 in the long run. Both values are drastically higher than the American equivalents. (Campa 682) Modon 7

Descriptive Results

While many Americans would say that the decrease in value of the dollar has a negative effect on our lives, this is not always the case. Similarly, not every individual or firm the Canadian economy benefits from having the Canadian dollar reach parity. For example, a benefit

Canadians enjoy because of the depreciation of the dollar is the ability to vacation cheaper in the

United States. A few years ago, many Canadians viewed coming onto American soil as an expensive trip altogether. Today, spending money in New England towns is no more expensive than spending Canadian dollars in Nova Scotia or Quebec. Adrienne Kearney, an economist at the University of Maine, says that the state economy has definitely been affected by the appreciation of the Canadian dollar. Because Canadians realize that their currency goes farther in the United States of 2007 than the U.S. in 2003, Maine has experienced a huge gain in the industry of tourism. State Tourism Office director Patricia Eltman noticed the affect of the exchange rate on tourism. She explains, “Anecdotally, the areas of Maine that cater most to

Canadian visitors have had one of the best summers in years…We recognize the importance of the Canadian visitor to our tourism economy, the huge opportunity that the current exchange rate represents, and appreciate that they are a very vital drive market for Maine.” (Leary) In addition,

Mike Allen, director of economic analysis at Maine Revenue Services, claims, “[Maine] can look closely at the sales tax revenues in regions close to the border and compare them to previous years….[W]hat we are hearing in news reports and from other people in the tourism industry that

August appeared to be a very strong month.” (Leary) At the same time, however, the depreciation of the dollar and appreciation of the “loonie” hurts major Canadian industrial suppliers. For example, the three major Canadian industries of manufacturing, lumber companies, and auto-parts makers, are suffering greatly because of expensive input costs. (“$1

Cdn = $1 US”) Heavy hitters in these businesses sell a great portion of their product to American consumers, and because the value of their sales is not the same in terms of Canadian dollars, firms lose out of profits. Another example involves Canadian investors in the U.S. stock markets.

Since the beginning of 2007, the Dow Jones Industrial Average has increased 10.6%. While this jump satisfies American investors, individuals from Canada are not nearly as content. Because Modon 8 their currency has experienced 15% growth, Canadian investors in American markets are actually experiencing a 4.4% net loss on their investment after adjusting for exchange rate differences.

(“Parity and Beyond”)

Conclusion

Since 2003, a huge shift in the value of the American dollar compared to the Canadian

“loonie” has occurred. This can be partly due to the trade deficit the United States runs with

Canada. Over the past four years, trade deficits have averaged between $4 and $5 billion monthly. This has allowed the demand for Canadian dollars to increase, calling for the exchange rate to be affected. The United States is experiencing the depreciation in the dollar compared to other currencies as well: although the Canadian dollar is up 16% in value since the beginning of this year, the euro is up 6%, and even the British pound has experienced an appreciation in value of 2% compared to the U.S. dollar. (“$1 Cdn = $1 US”) The overall trade deficit of the U.S. is probably a catalyst to the depreciation of the dollar across the board in recent years. Whether the dollar continues to depreciate in the upcoming years is unknown; however, basic economic principles suggest that the current U.S. trade deficits do not affect the country’s GDP in a beneficial way. Modon 9

Appendix

Table 1: Trade between US and Canada Trade Deficit Month Exports Imports Balance to Canada (since 2003) Jan-03 $12,889.70 $17,735.20 -$4,845.50 $4,845.50 Feb-03 $13,292.60 $17,183.50 -$3,890.90 $8,736.40 Mar-03 $15,359.60 $19,822.50 -$4,462.90 $13,199.30 Apr-03 $14,646.40 $18,454.40 -$3,808.00 $17,007.30 May-03 $15,208.00 $18,667.90 -$3,459.90 $20,467.20 Jun-03 $15,003.20 $18,574.30 -$3,571.10 $24,038.30 Jul-03 $12,029.50 $17,079.40 -$5,049.80 $29,088.10 Aug-03 $12,989.70 $17,584.30 -$4,594.60 $33,682.70 Sep-03 $14,518.10 $19,360.80 -$4,842.70 $38,525.40 Oct-03 $15,554.60 $20,137.70 -$4,583.10 $43,108.50 Nov-03 $14,598.20 $18,640.50 -$4,042.30 $47,150.80 Dec-03 $13,834.00 $18,354.20 -$4,520.20 $51,671.00 Jan-04 $13,315.80 $18,925.80 -$5,609.90 $57,280.90 Feb-04 $14,398.60 $19,356.60 -$4,958.00 $62,238.90 Mar-04 $17,227.00 $22,483.20 -$5,256.20 $67,495.10 Apr-04 $16,027.00 $21,498.60 -$5,471.70 $72,966.80 May-04 $16,311.40 $21,250.10 -$4,938.70 $77,905.50 Jun-04 $16,433.10 $23,250.80 -$6,817.80 $84,723.30 Jul-04 $13,863.80 $19,776.50 -$5,912.70 $90,636.00 Aug-04 $16,069.50 $22,018.30 -$5,948.80 $96,584.80 Sep-04 $16,633.10 $21,688.10 -$5,055.00 $101,639.80 Oct-04 $16,969.40 $22,410.90 -$5,441.50 $107,081.30 Nov-04 $16,675.50 $22,875.50 -$6,200.00 $113,281.30 Dec-04 $15,955.60 $20,825.50 -$4,869.90 $118,151.20 Jan-05 $15,568.40 $21,839.50 -$6,271.10 $124,422.30 Feb-05 $16,092.30 $21,502.50 -$5,410.30 $129,832.60 Mar-05 $18,919.80 $24,009.50 -$5,089.70 $134,922.30 Apr-05 $18,105.20 $23,458.00 -$5,352.70 $140,275.00 May-05 $18,327.10 $23,527.70 -$5,200.60 $145,475.60 Jun-05 $18,684.50 $23,672.20 -$4,987.80 $150,463.40 Jul-05 $14,719.60 $21,087.30 -$6,367.70 $156,831.10 Aug-05 $18,250.10 $25,041.30 -$6,791.10 $163,622.20 Sep-05 $18,368.30 $25,949.90 -$7,581.70 $171,203.90 Oct-05 $18,746.50 $27,725.00 -$8,978.50 $180,182.40 Nov-05 $18,417.30 $26,382.70 -$7,965.40 $188,147.80 Dec-05 $17,699.60 $26,188.60 -$8,489.00 $196,636.80 Jan-06 $17,261.10 $25,965.90 -$8,704.80 $205,341.60 Feb-06 $17,930.90 $23,750.00 -$5,819.10 $211,160.70 Mar-06 $21,153.30 $26,477.70 -$5,324.30 $216,485.00 Apr-06 $19,102.50 $24,836.80 -$5,734.30 $222,219.30 May-06 $20,489.60 $26,459.00 -$5,969.40 $228,188.70 Jun-06 $20,874.70 $26,544.20 -$5,669.50 $233,858.20 Jul-06 $16,621.10 $22,926.60 -$6,305.50 $240,163.70 Aug-06 $20,287.50 $26,299.20 -$6,011.70 $246,175.40 Sep-06 $19,249.10 $24,966.30 -$5,717.30 $251,892.70 Modon 10

Oct-06 $19,975.20 $25,080.80 -$5,105.50 $256,998.20 Nov-06 $19,730.00 $25,242.00 -$5,512.00 $262,510.20 Dec-06 $17,980.90 $23,889.40 -$5,908.50 $268,418.70 Jan-07 $17,777.00 $24,552.20 -$6,775.20 $275,193.90 Feb-07 $18,338.00 $23,061.00 -$4,723.00 $279,916.90 Mar-07 $21,992.00 $27,399.90 -$5,407.90 $285,324.80 Apr-07 $20,177.00 $26,012.10 -$5,835.10 $291,159.90 May-07 $21,777.00 $26,965.50 -$5,188.50 $296,348.40 Jun-07 $21,771.00 $27,627.90 -$5,856.90 $302,205.30 Jul-07 $18,780.00 $24,466.90 -$5,686.80 $307,892.10

NOTE: All figures are in millions of U.S. dollars. Source:http://www.census.gov/foreigntrade/balance/c1220.html#200 7

Figure 4

Works Cited Modon 11

Campa, Jose Manuel, and Linda S Goldberg. “Exchange Rate Pass-Through into Import Prices.”

The Review of Economics and Statistics 87.4 (Nov. 2005): 679-690. EconLit. EBSCO.

The U of Akron, Akron, OH. 4 Oct. 2007 .

Canada. Parliamentary Research Branch. Why Has the Canadian Dollar Been Rising? By

Michael Holden. JSTOR. 2 Dec. 2003. Library of Parliament. 30 Oct. 2007

Gagnon, Joesph E, and Jane Ihrig. “Monetary Policy and Exchange Rate Pass-Through.”

International Journal of Finance and Economics 9 (2004): 315-338. EconLit. EBSCO. The

U of Akron, Akron, OH. 4 Oct. 2007 .

Krugman, Paul, and Robin Wells, eds. Macroeconomics. New York: Worth, 2006.

Leary, Mal. “Canadian Dollar’s Stregnth a Positive.” Bangor Daily News. 1 Oct. 2007. Capitol

News Service. 5 Oct. 2007

articleid154862&zoneid=500>.

“$1 Cdn = $1 US: Loonie Reaches Parity.” CDC News. 20 Sept. 2007. Canadian Broadcasting

Corp. 5 Oct. 2007 .

“Parity and Beyond: How High Will the Loonie Go?” CBC News. 4 Oct. 2007. 5 Oct. 2007

Pinno, Karl, and Apostolos Serletis. “Long Swings in the Canadian Dollar.” Applied Financial

Economics 15 (2005): 73-76. EconLit. EBSCO. The U of Akron, Akron, OH. 4 Oct. 2007

United States. Census Bureau. “Foreign Trade Statistics.” Trade in Goods (Imports, Exports, and

Trade Balance) with Cananda. 7 Sept. 2007. 6 Oct. 2007

“U.S. Dollar to Canadian Dollar Exchange Rate.” Chart. Yahoo!Finance. 5 Oct. 2007. 6 Oct. 2007