Wednesday, February 5, 2014

Falling loonie is actually a benefit for most Canadians

From 2003 to 2008 the loonie skyrocketed, rising 60% in value. If you were rich it was definitely time to break out the champagne. All your wealth magically increased by 60% and you didn’t have to lift a finger or take the slightest amount of risk.

But what happened to average Canadians who spent all their time and money in Canada? Nothing.

Prices remained the same

According to Mike Moffat, the price difference remained the same. In 2003, Canadians paid $1.20 CAD for an item that sold for $1 US in America. After 2008, when the dollar reached parity, Canadians still paid $1.20 for an item that sold for $1 in the US.

With a 60% increase in value, prices should’ve come down dramatically. That would’ve caused deflation. But they didn’t.

Moffat tries to claim the Bank of Canada is the culprit: that its 2% inflation target kept Canadians from benefiting from a rising loonie. But the fact is he didn’t do his homework. From 2003 to 2008 the BoC didn’t increase the money supply or lower interest rates to offset deflation. Their policy actions were in line with the US Fed, which was to actually raise interest rates to counter inflation.

Falling loonie: same thing — nothing

The same thing happened when the loonie plummeted from 74 cents to 65 cents US, from 1997 to 1999: that is, nothing.

We should’ve seen an increase in prices that caused inflation. But what really happened? Inflation was 1% — lower than the 2% inflation target. We actually experienced disinflation.

So what’s really going on?

For the most part, it’s simply a case of supply and demand. When the dollar rises, purchasing power goes up, but so does demand. That means businesses can get away with charging more in US dollars. (Business charge the highest price the market will bear.)

When the dollar falls, purchasing power drops, but so does demand. That means businesses have to move more inventory to make the same profit — at a lower price in US dollars.

So that’s why average Canadians never see any difference.

Conclusion

Right-leaning Canadians are bitterly complaining that the falling loonie means “everyone will take a pay cut.” But in reality, only the well-off will suffer a loss. But they are not really suffering anything, because it was all free money to begin with.

According to the OECD, the value of the loonie should be 80 cents US (based on purchasing power parity.) A dollar at parity means exports are 25% more expensive and labor costs are 25% higher. That means businesses close up shop and move south of the border. That’s why the economy shed 500,000 good-paying manufacturing jobs and Canada went from a 2% GDP trade surplus to a 3% trade deficit.

An overvalued loonie is actually bad for the economy and bad for Canadians. It has a long way to fall before it can be considered “weak.”

1 comment:

  1. "The phrase "51st state" can be used in a positive sense, meaning that a region or territory is so aligned, supportive, and conducive with the United States, that it is like a U.S. state. It can also be used in a negative sense, meaning an area or region is perceived to be under excessive American cultural or military influence or control. In various countries around the world, people who believe their local or national culture has become too Americanized sometimes use the term "51st state" in reference to their own countries" and that is exactly what Canada is the 5lst state and the Harper Government is making sure it is. Posted by me...Anyong

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