FREE ESSAY ON DEPRECIATION OF THE CANDAIAN DOLLAR

DEPRECIATION OF THE CANDAIAN DOLLAR

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 Canada's 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 1996's
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 Canada's
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 Canada's online statistical database
But as Appendix 1 indicates, 1997 was the beginning of the gradual decent of the Canadian
dollar, until it reached it's low in August of 1998. This translates to the relatively
more expensive foreign products (imports), as Canada's 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 Canada's 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
currency's 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 government's 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
currency's devaluation was engineered by the Bank (of Canada)." Yet another source has
the same opinion, "The dollar's decline was intensified by the Bank of Canada's 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 Canada's 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 country's 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 government's 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 Canada's 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.