Falling loonie a good thing, experts say

Experts say the plunging loonie, now at its lowest level in more than three years, could help Canada weather a global economic slowdown by making exports more competitive, but things will be tough.
The Canadian dollar hasn't been below 80 cents US since mid-2005. ((Adrian Wyld/Canadian Press))

Experts say the plunging loonie, now at its lowest level in more than three years, could help Canada weather a global economic slowdown by making exports more competitive.

Canada's manufacturing sector suffered as the dollar soared above parity with the U.S. greenback last year for the first time in decades.

The strong dollar made Canadian-produced goods relatively more expensive and hurt export-based industries, particularly the auto and forestry sectors, which have lost thousands of jobs in the last year.

One hope for Canadian exporters is that the loonie's drop may soften the impact of a worldwide recession.

"It will help, but to the extent that the weak Canadian dollar is also a symptom of poor global economic growth, it's more of a cushioning of the recession rather than a cure for it," said Avery Shenfeld, a senior economist with CIBC World Markets.

He said the Canadian economy is too tightly intertwined with its American counterpart — reeling from the continued financial meltdown — for the currency exchange rate to reverse its woes completely.

The Canadian dollar was trading Thursday in North America around 80 cents US.

The loonie — which peaked at 110.31 cents US almost a year ago, last Nov. 7 — dropped 2.69 cents on Wednesday to end at 79.70 cents US. That was its first close under 80 cents US since June 2005.

Canada's forestry industry was hit hard when price of the loonie rose above $1 US. ((Jeff Bassett/Canadian Press))

The Canadian dollar is considered a commodity currency, meaning the decline in the price of crude oil, metals and minerals due to shrinking global demand has been a major factor in the loonie's fall.

December crude contracts were trading around $69 US on Thursday.

TD Bank chief economist Don Drummond said his benchmark for the dollar is 85 cents US, because Canada's economy is approximately 85 per cent as productive as that of the United States.

"We'll deviate from that depending on whether commodity prices are above or below their trend," Drummond said.

But the relative strength of the U.S. dollar against other major currencies recently is also having a major impact, said Steve Malyon, a currency strategist with Scotia Capital.

"It is a bit counterintuitive to have all this U.S. dollar strength, given that the subprime crisis started in the United States, but I think the key observation is that it started in the United States but it didn't stop there," Malyon said.

"It's sort of an ugly contest in global currency markets. The U.S. dollar doesn't look terribly great, but neither do a lot of other places."

Canadian Auto Workers union members protest in June against the proposed closure of the General Motors truck plant in Oshawa, Ont. The auto industry has been hit hard by the rising dollar. ((J.P. Moczulski/Canadian Press))

In fact, Malyon said, the loonie has fared comparatively well next to some of its peers, losing about 18.5 per cent of its value against its U.S. counterpart since July 1, while the New Zealand and Australian dollars have lost 22 per cent and 30 per cent, respectively.

The euro has seen a decline similar to that of the Canadian dollar.

The U.S. dollar has also been given a boost by investors eager to buy the currency to pay back debt, Shenfeld said.

"Investors that had borrowed in U.S. dollars and are now seeing losses on their investments are attempting to pay back their loans and are buying U.S. dollars in the process."

Rising prices for everything from bananas to computers are another persistent worry when the dollar drops, as goods imported from the U.S. and other countries suddenly cost more.

But this time, a global slowdown in demand combined with lower costs for raw materials is making consumer goods cheaper and should therefore insulate the Canadian economy from inflation, said Malyon.

"The decline in commodities has been far greater than the decline in the Canadian dollar," he said.

"When you net it all out, we have a fairly significant disinflationary pulse that's going to work its way through the economy."

'This is the way it's supposed to work'

Drummond said this is exactly the way a floating exchange rate — or a currency with a value that changes in relation to other currencies — should work.

"We're freaked out when it goes up a lot and when it goes down a lot, but we have to step back and think, 'This is the way it's supposed to work,' " he said.

"When commodity prices go up, your dollar should appreciate, and it mitigates some of the inflationary pressures coming from that, and when the dollar goes down, it mitigates some of the disinflationary pressures, so it smooths out your economic activity. As hard as it is to watch that kind of volatility, it is doing the job it's supposed to do."

Malyon added that this should allow the Bank of Canada to continue cutting interest rates to stimulate the economy, at least in the short term.

The central bank lowered its overnight lending rate by a quarter point on Tuesday after a half-point cut on Oct. 8 in an attempt to stimulate the economy by encouraging borrowing.

George Davis, a senior technical analyst at RBC Capital Markets, said he expects the loonie to continue its decline in the short run.

"Until we see credit markets stabilize, which would also imply some sort of stabilization in commodity and equity markets, I think that's going to imply weaker days for the Canadian dollar ahead," Davis said.

But Shenfeld sounded a more optimistic tone.

"In the near term, the continuing turmoil on financial markets is going to put some downward pressure on the Canadian dollar, but we likely have room for a substantial recovery when the global economy is back on its feet," he said. "I wouldn't expect this to last that long."