Strategy

Outlook 2010: What's next for the loonie?

The dollar looks likely to remain strong for a while now. But does it really matter?

The loonie is a tricky bird. Over a decade ago, when government deficits led The Wall Street Journal to list Canada an “honorary member of the Third World,” more than a few observers insisted our currency was destined to be worth less than half a U.S. buck. Nobody called the flight from less than 63centsUS in 2002 to US$1.09 in 2007. That was followed by a surprise descent to under 80centsUS. Then, it fooled the market again in early 2009. “What’s gotten into the loonie?” EDC economist Peter Hall asked after the dollar spread its wings last April and soared 12cents in 29 days. “The loonie’s recent surge,” he concluded, “looks temporary.”

Hall had to eat his words in September, when he noted the dollar’s move above 90centsUS “seems to be sticking.” He predicted exporters are in for a rough ride — and he may be wrong again. As Sheryl King, an economist with B of A Merrill Lynch Global Research, points out, Canada’s trade balance returned to surplus in October, when the loonie rose 2.4% — discrediting the “view that the Canadian trade sector is incapable of growth with a strong currency.”

Calling a coin toss is easier than predicting exchange rates. But the loonie’s climb above 90centsUS last year should not have been such a surprise. After all, the strength of Canada’s dollar is more than just a weakening-greenback story. And it’s not all about being a petrocurrency. Simply put, the Canuck buck has become an attractive alternative to the world’s ailing reserve currency. Last November, for instance, Russian central banker Sergei Shvetsov was out shopping for Canadian dollars. According to a report by Benjamin Reitzes, an analyst with BMO World Markets, other central bankers will follow suit — if they haven’t already — because “Canada’s fiscal position is relatively favourable among developed economies and the financial system has ranked as the soundest globally for a second consecutive year.”

Bank of Canada governor Mark Carney has warned that a strong loonie threatens GDP growth. He could attempt to manipulate the exchange rate down. CIBC World Markets economist Avery Shenfeld thinks that is needed to protect our industrial base. “To those who say intervention never works,” he noted in a commentary last year, “China has steered the yuan exactly as it pleases.” Then again, nobody seriously argues intervention is impossible; they just point out Canada lacks the clout to really play the game. The international community, on the other hand, could clip the loonie’s wings by working together to prop up the U.S. dollar. That was jointly achieved in 1985 (and jointly reversed in 1987), but those actions were supported by Washington. These days, benign neglect appears to have replaced the official U.S. strong-dollar position.

The greenback showed renewed signs of life as the world put 2009 to bed. But if all goes well for the global recovery, central bank activity and speculative demand will put upward pressure on the loonie this year, especially if the Bank of Canada increases rates before the U.S. Federal Reserve does. Still, nobody should be ringing alarm bells. Clearly, jobs related to tourism, forestry and manufacturing are threatened when the loonie jumps. But Canada imports roughly as much as it exports, and most industries are relatively neutral to a rising currency. And a healthy chunk of recent imports comprises tech and equipment upgrades that can help put our businesses in the global game.

Softer growth and low inflation resulting from a surging loonie help households control debt. And despite currency movements, not tomention a weak global economy, Canadian employers added 79,100 jobs across all sectors in November (when the unemployment rate dropped to 8.5%). That was more than five times expectations and included 12,600 new jobs on factory floors.

Finally, there are two things most likely to ground the loonie, and nobody should hope for them. A new financial crisis would create another irrational flight to the perceived safety of U.S. assets. And in the longer term, a returning taste for deficits among our politicians could eventually renew Canada’s Third World club membership.