Loonie's rise made in U.S.A.
By JAY BRYAN, The Gazette October 14, 2010 With the Canadian dollar rising near parity with the U.S. greenback yesterday, it's reasonable to ask why this is happening and how far it can go.
While nobody has an entirely clear crystal ball, the answer is that we might see this period of currency strength last for several months, maybe longer. It depends largely on developments south of the border.
This is because the ultra-easy monetary policy of the U.S. is probably the single biggest reason for the loonie's apparent strength.
While Canada has real, durable economic advantages, they aren't enough to push our currency up as far and fast as it's moved in the past several weeks -a gain of about five cents since early September. It's more a case of shrinkage in the yardstick against which we measure our dollar: the once-mighty U.S. greenback.
How long will this be the case?
While we've seen the loonie rise to equality with the U.S. dollar before, it's not usually a long-lasting phenomenon. Canada's economy is far less productive than that of the U.S., and most economists would agree that the fundamental value of our currency is well below that of our big neighbour: maybe 85 to 90 cents.
On the other hand, a currency can stay far above or far below its fundamental value for years if flows of capital keep it there. During most of the 1990s and early 2000s, one could argue convincingly that the loonie should have been trading well above its market value, which was below 63 cents U.S. as recently as 2002.
About then, it began strengthening, until by late 2007, soaring global prices for oil and other resource products, which are big export earners for this country, helped to push our dollar several cents above parity for a few weeks.
It then hovered near parity through the first half of 2008 -until the global financial crisis brought it down to Earth with a thump.
With Canada enjoying a milder downturn and stronger recovery from the recession than the U.S., the loonie bounced from recession lows below 80 cents to hover in the high 90s most of this year, even touching parity briefly last April.
The dollar is now benefiting from rising belief that the U.S. Federal Reserve system is about to resume using a technique it tried in the depth of the financial crisis last year. It's known to economists as quantitative easing, but most people just call it printing money.
The idea is that if an economy doesn't perk up much once a central bank has cut interest rates as low as they can go, this is the major weapon it has left.
It can work largely because the only interest rates a central bank controls directly are short-term ones, but in a very tough economy, it can create new money in order to buy up longer-term bonds and other securities, forcing down longer-term rates, too.
The lower long-term rates could help support the deeply troubled U.S. housing market by making it even cheaper to take a mortgage loan and might also have some impact on businesses that need long-term funding in order to expand.
How does all this affect the Canadian dollar? Well, when it's clear that U.S. interest rates are going to stay low for a long time, the incentive for investors to look elsewhere for a better return on their money becomes pretty strong.
An investor looking for a two-year government bond recently could get 1.32 per cent on a Government of Canada issue, but only a paltry 0.35 per cent on an equivalent U.S. government bond.
This creates enormous pressure for funds to flow out of the U.S. and into countries with higher yields, like Canada.
As well, Canada's resource-heavy stock market has recently looked like an increasingly good bet as the price of commodities like oil and copper soared. Copper is up 32 per cent from its low point in July, calculates Diana Petramala, an economist with the Toronto-Dominion Bank.
How long will the party last? Petramala suspects that with the Bank of Canada likely to halt its campaign of rising interest rates next week, the flow of funds supporting the loonie could taper off, leaving it to subside a bit later this year.
But Douglas Porter, deputy chief economist at BMO Capital Markets, thinks this could be a longer-lasting phenomenon.
The next round of quantitative easing in the U. S, which is likely to begin within another month or so, could have an impact that will last for many months. Meanwhile, resource prices remain strong.
Porter thinks this will maintain pressure on Canada's dollar to reach and surpass parity -he's guessing about $1.05, probably next year -although it's not clear how long this will last.
jbryan@montrealgazette.com.
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