Canadian Dollar Depreciation

     Canada has been increasing its prestige as a high-tech, industrial, society
since the end of World War II. In many ways it resembles very closely its
southern North American cousin, the United States. Some of those similarities
are residing in its market-orientated system, pattern of production, and its
high standard of living. Most years following the war up to the present, Canada
has experienced some kind of continued growth as a prosperous and developed
country. However, during the year of 1998, Canada experienced an unexpected
large depreciation in their dollar relative to the United States. Late in August
of that year, in fact, the value reached an all-time low. During this paper, I
will try to present some of the possible economic factors that may or may not
have led to this change in Canada’s exchange rate. I will also examine some
additional analysis and theories as to why the trend possibly occurred. Exchange

Rate As the year 1998 approached, the trend for the Canadian dollar was on a
steady decrease in value in relation to the U.S. dollar. With each passing year
the dollar lost some value as the table below demonstrates. Year 1990 1995 1996

1997 1998 Exchange Rate 1.16 1.38 1.36 1.38 1.48 *All data tables extrapolated
from the Cambridge Forecasts Country Report, unless otherwise noted. It took an
exceptional hit during the year, moving the rate from 1.38 U.S. dollars to 1.48
in U.S. dollars. The plunge is better exhibited in Appendix 1, with the sharp
decrease of the dollar illustrated graphically and more specifically, with

Appendix 2 showing the drop throughout the year of 1998 alone. Growth Rate In
terms of growth rate, the years leading up to the exchange rate drop in 1998
showed very typical numbers. There was nothing out of the ordinary, or anything
to hint at a sharp decrease in the value of the Canadian dollar. As highlighted
below, up to 1998, the economy was growing at a slow but steady rate each year.

Both the Total Gross Domestic Product and percentage of GDP real growth were
increasing overall. Year 1990 1995 1996 1997 1998 GDP (bill. of U.S. $) 573966

584044 611602 631193 603978 Year 1990 1995 1996 1997 1998 GDP Real Growth (%)

N/A 2.3 1.6 3.7 3.1 However as the numbers for 1998 indicate, the depreciation
of the dollar definitely took a significant chunk out of the Total Gross

Domestic Product, dropping it below 1996’s levels. This is to be expected as a
depreciated currency would effect the value of the products, however as pointed
out before, nothing in growth rate eluded to the depreciation that took place in

1998. Inflation Rate Similar to the growth rate, the inflation rate also had
nothing to offer in terms of an indication of the lowering exchange rate. In
fact, as highlighted below, the inflation rate was steadily declining as 1998
approached. A trend usually linked to a healthy economy overall. Year 1990 1995

1996 1997 1998 Consumer Price Inflation N/A 2.2 1.5 1.6 1.0 Even the figures
from 1998 indicate, the inflation rate seemed to be unaffected by the
depreciation of the Canadian currency. "...that (increase in) performance (of

Canadian companies), is due almost entirely to the depreciation of the currency
and, to a much lesser extent, to the lower inflation that Canada has experienced
during the last decade..." Therefore using the inflation rate as an economic
indicator in this case is not always conclusive to the ideal that the dollar
should have been in good shape, with a thriving economy. Dollar Reserves Again,
looking at the numbers of dollar reserves, no significant trend seems to point
in the direction of increased weakening. Year 1994 1995 1996 1997 1998 Dollar

Reserves (mil of U.S. $) 392 -2710 -5498 2392 N/A The fluctuations in the
numbers seem to be quite normal and constant throughout Canada’s time of both
economic prosperity and slowdown. Trade Balance The trade balance however starts
to show a different story. The numbers up to 1997 look very healthy with the
amount of exports far outweighing the imports. 1997 spelled a big decrease in
the trade balance and the numbers from 1998 show much of the same. Year 1994

1995 1996 1997 1998 Exports (mil of U.S. $) 228,167.10 265,333.90 279,891.80

301,381.40 322,262.40 Imports (mil of U.S. $) 207872.50 229936.50 237917.20

277707.80 303399.70 Trade Balance 20294.60 35397.40 41974.60 23673.60 18862.70
*Data extrapolated from CANISM, Statistics Canada’s online statistical
database But as Appendix 1 indicates, 1997 was the beginning of the gradual
decent of the Canadian dollar, until it reached it’s low in August of 1998.

This translates to the relatively more expensive foreign products (imports), as

Canada’s ability to purchase and make good on its domestic products (exports)
being sold overseas decreases. In other words, the cost to buy foreign products
rose while the amount of money taken in on imports when converted to their
currency fell. This is again demonstrated as you look at the amount of exports.

It continues rise, but not as quickly due to the lower exchange rate. Couple
that with higher prices paid for the imports equals a significant decrease in
the trade balance. The balance in 1998, in fact, was lower than the balance in

1994. Interest Rates A final economic indicator that helps us to explain the
reasons behind the exchange rate drop is to look at a few of the key interest
rates in the economy in and around that time. Year 1995 1996 1997 1998 1999 Bank

Rate 7.31 4.53 3.52 5.1 4.91 Prime Business Loan Rate 8.65 6.06 4.96 6.6 6.43

Consumer Loan Rate 11.88 9.19 8.75 9.27 10.18 *Data extrapolated from CANISM,

Statistics Canada’s online database As exhibited with the figures, there is
serious decrease in all of these interest rates from 1995 to 1996. "1998
started off well enough, but by mid-year the optimism was being abruptly clouded
by a decreasing currency, which seemed to be related to the low rates of
interest being charged." This decrease demonstrates a strong economy at this
time, but with them being too low, it causes a capital inflow to the country, in
turn making the currency’s value depreciate as more of it is supplied and
demanded. The trend in 1997 and 1998 indicates that the interest rates are
starting to climb again with hopes to regain the original strength the dollar.

Other Factors Besides these basic economic indicators two other main factors
influenced the depreciation of the Canadian dollar. The first of these resting
in the hands of the Federal government’s action, or as some would put it, lack
of action. The Prime Minister and finance minister did nothing in terms of
trying to stop this devaluation of the dollar. In fact, they encouraged it.

Their thinking was that a weakening dollar would reduce the labor costs of many
companies, therefore increasing the amount production and increasing margins.

The opposite occurred. With the lower value of the dollar, companies were less
motivated to innovate and reduce costs because they were so sheltered by the
strong foreign competition. The weaker dollar also raises the price of machinery
and equipment, which of it, 60% is imported. With these factors comes a decrease
in competition with the foreign firms and overall decrease in the health of the
country. Jeff Rubin, an economist at CIBC World Markets agrees that this
depreciation in the currency has also had a "huge erosion in
competitiveness." Mr. Rubin also agrees that the lack of action taken by the
government has hurt competitiveness. "...the protective aspect of the a weak
dollar is to blame for the plunge in competitiveness and that the currency’s
devaluation was engineered by the Bank (of Canada)." Yet another source has
the same opinion, "The dollar’s decline was intensified by the Bank of

Canada’s benign neglect through early August (1998) and the apparent
indifference expressed by the government." Some would also argue that tied
along with this deterioration in competitiveness, is the influence the Asian
currency crisis had on the Canadian dollar. The depreciation of the dollar was
one of the most visible impacts that crisis in Asia had on Canada’s economy.

The crisis over there demonstrated a lower demand and prices for commodities,
not to mention the perception of Canada being able to compete in the global
market. It also caused other countries to question its other policy and
structural issues that take away from the country’s attractiveness to
investors. Conclusion To conclude, the depreciation of the Canadian dollar had
many influences hinging upon it. Some of the key economic indicators were
unfazed by the devaluation, while others were heavily affected. These and the
outside factors of the Canadian government’s ignorance of the problem and the

Asian currency crisis all added to the already confusing mix of speculations. A
quote in the article by Janet Matthews ties it altogether best, "...if we have
learned anything from the last 18 months, it is that only the longest of
perspectives is likely to be of any use when looking a Canada’s economy. This
period since May 1998 has been characterized by so many ups and downs that it is
easy to jump to conclusions when looking at economic performance statistics."

Many economists did. They believed that this depreciation would cause a long
term economic slowdown for Canada but as current facts indicate, the dollar has
regained some of its strength and contrary to predictions, the economy is again
growing and improving at a steady rate.