The Two Sides of the Appreciating Dollar: Heads or Tails? (a Cdn perspective)

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The Two Sides of The Appreciating Dollar:
Heads or Tails?

Many Canadians stand proud when someone mentions the value of the loonie compared to the greenback.
But, should they? Yes and no.

Since the beginning of the year, and especially this fall, the Canadian dollar has been on a crazy roller coaster ride!
 
In truth and fact, should we be happy that our currency has become the darling of the world's major speculators? Obviously, a strong dollar has all sorts of advantages, but it also has risks, especially when its fluctuations (and their consequences) are beyond anyone's control.

What do you call an investment that grows 10% in a week ... then loses almost the entire gain the very next week? A volatile investment? Well, this volatility now applies to our dollar, with all its advantages and all its risks.

Exceptional

The following graph really hits home. For the better part of the 20th century, the loonie was almost at par with the greenback. It's only in the late 1970s, because of inflation and government deficits, that it started to decline and finally drop to $0.62 US in 2002. And now, in less than 5 years, it's managed to get back everything it lost in the previous 25 years. Since January, the loonie has regained almost 20%. What's so exceptional is not that it's back at par (and even higher), but how quickly it got there. Indeed, our dollar has become an object of speculation.



Heads - the advantages

Here, there are three major winners.

• The consumer
  Even if some businesses have yet to adjust their prices, the price of some foreign goods and services are now better than before. For the consumer, this is, in essence, an increase in salary.

• The traveller
  All major currencies have increased compared to the US dollar, but the loonie has increased more than all the others - and has even appreciated compared to other currencies. On Time Square, a pretzel costs 19% less than at the beginning of the year. A ham and cheese sandwich on the Champs-Élysées, 6% less. Nachos in Puerto Vallarta, 21% less. And braised beef in Buenos Aires, also 21% less.

Increase in the Canadian dollar compared to other currencies

January 2, 2007 to November 19, 2007

Currency	Jan. 2	Nov. 19	Increase
Mexican peso	9.25 p	11.18 p	+ 21 %
Argentinean peso	2.65 p	3.20 p	+ 21 %
US dollar	0.86 $	1.02 $	+ 19 %
British pound	0.43 £	0.50 £	+ 16 %
New Zealand dollar	1.21 $	1.35 $	+ 12 %
Yen	102.00 ¥	111.88 ¥	+ 10 %
Euro	0.65 €	0.69 €	+ 6 %
Australian dollar	1.08 $	1.15 $	+ 6 %
Source : Bank of Canada

• The import industry
  Businesses can now make larger investments in technology, often from the U.S., allowing them to improve their productivity. After 30 years of a weak dollar, it's high time to catch up.

Tails - the disadvantages

There are also three major losers ...

• The investor
  Other things being equal, every time the loonie gains strength, our foreign investments depreciate by the same amount when converted into Canadian dollars. With the loonie's 20% gain since the beginning of the year, the return from the U.S. Stock Exchange, which is already anaemic, is cancelled by the exchange rate. In other words, the strong loonie has decreased the benefits of geographical diversification.

• Export companies
  Companies that export more than they import are really getting a beating. Think about it.  A piece of machinery selling for $10,000 US in 2002 brought in $16,200 Canadian. Now? It brings in $6,200 less!

• Workers
  The loonie has already caused nearly 200,000 manufacturing jobs to be lost, especially in the eastern part of the country. But the long-term effects might be more insidious. Many economists forecast a slowdown in consumer spending and growth in the U.S. Along with an already fragile export industry, such a slowdown would not bode well for our economy, our businesses ... and our workers.

What to do?

• As a consumer and as a traveller
  It wouldn't be right not to take advantage of the strong Canadian dollar while it lasts ... But, it's important to be intelligent about it. For example, if you go to the States to purchase something and withdraw money from an ATM, a 2.5% conversion rate and a $3.00 transaction fee are generally applied by the banks. As such, a $100 withdrawal immediately loses 5.5% of its value. There are much better ways of taking advantage of the strong loonie!

• As an investor
  Investors have the choice of adjusting their portfolio according to an appreciating loonie or according to its future depreciation. Hedge funds can help protect a portfolio against a rising dollar's effects on the value of foreign investments. But, in the case of a depreciating dollar, the best policy will be to stay put and let those investments gain value by themselves. In this regard, this may well be the right time to reload our portfolios with U.S.-based mutual funds, at a much lower cost than in recent years. Having said this, it's important for us to consider such options before making any decision because, given the current situation, it will necessarily involve some degree of speculation.

• As a worker
  People working for companies that rely heavily on exports should be especially careful. This is certainly the case in the wood, paper, furniture, transportation, machinery and tourism sectors. There may be hard times ahead. This is not the time to spend foolishly or to get into debt. In fact, making sure to have a financial cushion to fall back on would be a much wiser choice.

Obviously, not everything is rosy for the loonie, but not everything is desolate either.
Each person's specific situation decides if it falls heads ... or tails.

Hope That Helps,


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