Canadian dollar discount days are here again.
That’s going to inflict pain in some areas of the economy and improve prospects for others.
But for manufacturers like Burnaby’s Williams & White Group of Companies, as much or more pain is being inflicted on businesses by the Canadian dollar’s chronic exchange rate volatility.
The 40-employee machining, fabricating, manufacturing and robotics company founded in 1957 does between 30% and 40% of its business in the United States. Rapid changes in the Canada-U.S. exchange rate complicate that portion of its business significantly.
“It’s hard to keep up with your pricing,” said company CEO Justin Williams. “You quote a customer, and then a month later, they want the same price; and Americans don’t always understand that the dollar has changed.”
Many also don’t always appreciate that there are two distinct dollars in North America.
Canada’s recent February 2012 to January 2013 flirtation with parity considerably reduced the cross-border competitive edge of many Canadian exporters.
On the flip side, the run of sub-US$0.70 dollars in the late 1990s and early 2000s eroded Canadian innovation and productivity by increasing the price of imported machinery and other technology upgrades and propping up weak operations reliant on an anemic dollar as their lone competitive edge.
But the value of the Canadian dollar relative to other currencies is only one measure of the country’s economic health. Purchasing power parity (PPP), which the OECD (Organisation for Economic Co-operation and Development) measures for countries around the world, and The Economist’s Big Mac index calculate a currency’s value based on how much of it is needed to buy a group of products or product. Both provide comparisons of living standards between countries and can gauge how much a currency is under- or overvalued in the world market.
The OECD’s PPP measurement includes approximately 3,000 consumer goods and services, 30 government occupations, 200 types of equipment goods and about 15 construction projects; the Big Mac index is focused on how much a Big Mac costs in each country.
According to the PPP theory, the exchange rate between two currencies is balanced when the currency’s purchasing power is the same in each country. So if that OECD basket of goods in Canada and the U.S. costs $125 and $100, respectively, the balanced exchange rate would be $1.25 = US$1.
According to that measurement, the Canadian dollar was significantly undervalued back in the late 1990s and early 2000s when it was trading at between US$0.62 and US$0.70 and its OECD PPP was ranging around US$0.84.
The OECD’s current PPP ranking puts the Canadian dollar at $US0.81. So, according to PPP principles, even with the dollar at around US$0.90, companies in B.C. are still getting a good deal in the marketplace.
But economists and financial analysts disagree over the PPP’s value in determining currency valuation.
According to Helmut Pastrick, chief economist with Central 1 Credit Union, “PPP exchange rates measure price level differences between countries, which is not the same as measuring valuation.”
As he pointed out, exchange rates are influenced by more than the price differences calculated by PPP.
Those factors include trade and capital flows and political stability. Add in interest rates, supply and demand for the currencies and long-term exchange rate averages.
However, Werner Antweiler, a professor of economics at UBC’s Sauder School of Business, points to the OECD’s PPP calculations as “the gold standard for what is a fair valuation” for a currency.
The Big Mac index, he said, includes a consistent cross-section of economic activity, inputs and services that go into a product – a McDonald’s hamburger – built with the same ingredients wherever it’s made. For example, The Economist’s “burgernomics” determined that at market exchange rates, as of January, a Big Mac in the U.S. was US$4.62 and in China was US$2.74. Therefore, according to the Big Mac index, the yuan was undervalued by approximately 41%.
Antweiler said that while the accuracy of the measurement is open to debate, the Big Mac index and OECD PPP provide insights into wage, productivity and other cost factor comparisons between countries.
“Looking at the changes over time gives you a very good sense of what is moving … and the trends that are emerging.”
As to what market forces have contributed to the Canadian dollar’s swoon since February 2013, Pastrick said they include strong downbound market momentum, “which is difficult to break or shift unless there is a significant development in the opposing direction.”
Also on the laundry list of negative factors: weaker commodity prices, last year’s global economic slowdown, a drop in building permits and the loss in December of 46,000 jobs from the Canadian economy, coupled with weak economic data and the Bank of Canada’s decision in January to keep its target overnight interest rate at 1% because of low inflation expectations and surplus supply in the economy.
Household debt in Canada also continues to be a concern.
As pointed out in “Debt and deleveraging: Uneven progress on the path to growth”(McKinsey Global Institute, January 2012): “In Canada and Australia, there are concerns about the high ratio of household debt relative to GDP, even though neither country has experienced a banking crisis.”
According to Equifax Canada’s fourth-quarter 2013 National Consumer Credit Trends Report, the consumer debt load in Canada is now $1.42 trillion. That’s up 4.5% from the third quarter, and represents a debt number that Cristian deRitis, senior director of consumer credit economics at Moody’s Analytics, said, “certainly raises eyebrows. It’s a number that seems to defy gravity.”
Canada’s export performance has also taken a caning globally.
As Bank of Canada senior deputy governor Tiff Macklem told the Economic Club of Canada late last year, the country’s exports in the wake of the financial crisis “were harder hit than in any post-war recession, decreasing by 17% over three quarters.
“Our exporters are adapting, but it has been gut-wrenching,” Macklem said.
According to Andrew Saxton, parliamentary secretary to the minister of finance, the drop in the Canadian dollar also has much to do with the rise of its American counterpart.
“A major factor in our dollar’s recent depreciation is the appreciation of the U.S. dollar,” he said in an email to Business in Vancouver, “which is largely a reflection of the greater than expected improving economic conditions in the U.S.”
There is a wide range of winners and losers when the dollar falls.
On the entertainment front, for example, B.C.’s film business is a big fan of a lower dollar, which makes it cheaper for high-rolling American film productions to be made in this province.
But the Vancouver Canucks, whose $64 million player payroll is paid in U.S. dollars but whose home-game gate receipts are gathered in Canadian dollars, are far less enthusiastic about a low Canadian dollar, especially when it also has negative implications for league revenue and, ultimately, team salary caps.
So somewhere among exporters and importers, filmmakers and pro sports teams is the optimum exchange rate for B.C. and the rest of Canada. For the BC Chamber of Commerce, that sweet spot, according to its president and CEO, John Winter, is around US$0.90.
“With exports still lagging from the global recession, a lower currency could be the kick-start these companies need to further grow their business and create the jobs that go with it.”
Winter added that it could also benefit B.C.’s retail sector by slowing the southbound tide of cross-border shoppers.
While Antweiler said Canada’s current US$0.81 PPP means most Canadians and Canadian companies are still getting a far better exchange rate deal today than they were back in the early 2000s, he pointed out that the Canadian dollar has also been losing ground against other key currencies, including the British pound and the euro, “and that is more worrisome.”
Antweiler agreed with Williams’ point that exchange rate volatility is as difficult for businesses to manage as is a rising or falling dollar.
He said that while some larger companies can afford to hedge against currency exchange rate volatility – by buying foreign currency – their smaller counterparts don’t have the same resources or abilities to insulate themselves against relatively sudden sharp rises and steep declines.
“They get hammered very quickly by what is happening in the marketplace. What we like as businesses is predictability and stability, and when we have these wild swings in exchange rates, this is not good.” •
