The Canadian dollar is a hottie just now, but what comes next?


Don Pittis has reported on business for Radio Hong Kong, the BBC and the CBC.

Will it continue its rise to $1.25 US as some have predicted? Or will it fall back like the last time it hit par?

There have been many predictions, but the honest economic answer is: "We haven't got a clue."

Being one of the business guys here at the CBC, people often come up and ask me about where the Canadian dollar will be, say, next August, when the person who is asking is taking his next trip abroad.

In the process, I've discovered that people don't like it when you say you don't know.

It's as if a real economist would have a chart of the future value of the Canadian dollar month by month. To the penny.

Even when I say I don't know, they always insist that I make a guess anyway.

My colleague, CBC host Fred Langan, has a good standard response for situations like this: "If I knew the answer," he will say, "I wouldn't be working."

Better than guesswork?

Fred's answer, of course, is because betting on currency exchange rates would be an easy way to make money. That is, if you knew where the currencies are heading next. And that's a big if.

Unlike Fred, I tend to a long-winded description of an Economist magazine article I once read, which demonstrated how utterly wrong predictions are about exchange rates.

Today, using the internet time machine, a CBC subscription and several experiments with key words, I actually went back, way back, to October 1999 and dug the article up.


Weighing in on a rising loonie. (Canadian Press)

There it was, just as I recalled. (What a memory! Someone tell my wife.)

"Better than guesswork?" was the title. The article had an even more revealing subtitle: "Economic forecasts of every kind are pretty unreliable — but few more so than forecasts of exchange rates."

You can look up the article yourself on the Economist website. But the essence of it is that the most logical, common-sense ways of predicting what a currency will be next year just don't work.

Currencies with higher purchasing power — meaning the ones able to buy more eggs or Big Macs at current exchange rates — do tend to rise, but only over the very long term.

Until that future day, they zigzag down and up and all over the place.

The seriously rich

One traditional method of guessing is to assume currencies will rise or fall to make the interest rates on government bonds even out between countries. 

But that method is even worse than simply assuming exchange rates next year will be identical to what they are now.

Like so many things in economics, the reason for uncertainty is complexity.

But despite that complexity, some people still insist they can make money playing the exchange rates.

I had an acquaintance in Hong Kong who was convinced he could do just that.

He was an Englishman who drove a Rolls Royce and lived in a sprawling flat in the upscale district called Mid-Levels.

In one way, our lives were miles apart, literally and figuratively. I lived in 200 square feet in the New Territories and took the subway into Central to my job as a business reporter.

My friend, a private banker with one of the big Swiss banks, looked after the money of Hong Kong people he described as "seriously rich," a status that in those days could be attained with a mere $10 million.

Hot money

The cash he handled was what we call "hot" money. That is the kind of investment that has no real commitment to location.

Unlike your family business, hot money doesn't care about the long-term strength of the local economy. It moves in when things are going up. When things stop going up, it moves on.

My Swiss banker said that hot money always thinks of currency first.

It seems obvious when you hear it. Stocks in a South African company may be heading up 10 per cent. But that does no good for a hot money investor if the South African rand falls five per cent in value.

So when hot money invests, it looks for good investments in countries where the currency has a good chance of rising as well.

I'm not sure if my Hong Kong acquaintance is still investing. If he is, I'll bet he has been buying a bit of Canada over the last while.

But hot money is fickle. Now that the loonie has had its run-up, who knows where the hot money will go next.

Reading a recent Financial Times blog called Alphaville my eyes ran across the following two quotes from an International Monetary Fund report: "Capital inflows can come to a sudden stop."

And later, "inflows may lead to exchange rate overshooting and risks to financial sector stability."

As I've said before, in a free market, if everyone thinks a free-floating currency like the Canadian dollar is on the way up, well then up it will go.

So, for this week, at least, the Canadian dollar is a hottie.

But hot money is just one of the complications in a complex world economy where the unexpected black swans, like a ( grey swans?) Icelandic cloud of volcanic ash, can wipe out millions of dollars in a day.

That's why predicting currencies is only a job for people betting with other people's money.

I don't know where the dollar is heading next but there is one thing I can tell the dear old loonie that is definite and for sure.

When you're hot you're hot. But don't forget the line in the song that comes next.