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_Depreciation of the Candaian Dollar _
By: Silky C
Scott Christiansen December 10, 1999 Economics 335 Section 01 Final Paper
The Depreciation of the Canadian Dollar 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 Canadas 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 1996s 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 Canadas 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 Canadas online statistical database But as Appendix 1
indicates, 1997 was the beginning of the gradual decent of the Canadian
dollar, until it reached its low in August of 1998. This translates to the
relatively more expensive foreign products (imports), as Canadas 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 Canadas 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 currencys 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
governments 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 currencys
devaluation was engineered by the Bank (of Canada). Yet another source has
the same opinion, The dollars decline was intensified by the Bank of
Canadas 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 Canadas 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 countrys 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 governments 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 Canadas 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
Word Count: 1597
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