Over the past year following the onset of the recession, investors and speculators have scrambled for a place to put their money. They have opted for the U.S. dollar.
Mixed results for Canada have emerged.
What are the reasons for this trend, and is this sustainable? The impact on Canada depends on some answers.
First of all there is an old saying in the financial community that one should not argue with what the markets are saying. Nevertheless, occasionally it becomes clear that a different point of view is justified. That is the situation with the current scramble for U.S. currency.
The economy south of the border appears to be relatively strong, while others in Europe and Japan are going in the opposite direction. Predictions suggest that the U.S. economy will continue to outperform most other nations. Furthermore, there are indications that the U.S. central bank will raise interest rates while others are cutting them.
The Bank of Canada cut rates in the spring. These changes will accentuate the move to the United States, as people want to earn the higher return.
Companies around the world, notably in emerging markets, have been filling up on dollar-denominated debt lured by the lower rates compared with local currency debt.
Given that background, a sharp fall in commodity prices has taken place. If the U.S. dollar rises, commodity prices fall as it would take less dollars to buy them. Hence, a higher U.S. dollar entails lower commodity prices. For instance, over the past year the price of oil has dropped more than 50 per cent, copper has fallen by about one-third. That hurts our commodity-based economy.
On the other hand, exports will be worth more when they are translated into the U.S. dollar.
Thus, gold for instance, at about US$1,200 an ounce, would be $1,498 in Canadian funds. In other words, the drop in commodity prices would be partly offset as our exports in Canadian currency would be worth more.
Thus, the overvalued U.S. dollar presents a mixed picture for our economy.
The question: is the U.S. dollar overvalued? The answer is emphatically yes, for several reasons. The U.S. foreign trade account runs a deficit of several hundred billion dollars a year while ours is in surplus.
Clearly, U.S. prices are too high, non-competitive. Also, the U.S. federal budget has an annual shortfall of nearly one trillion dollars while we have balanced budgets.
Too, the U.S. government is dysfunctional, paralytic and unable to accomplish much, even gun control. That nation is like Britain in the late 19th century, going into a decline.
Hence, the U.S. dollar sooner or later will reflect all this and drop. Perhaps then the Canadian economy will experience a renaissance.