Sunday, September 30, 2007

Canadian Dollar May Not Fly That High

The Soaring Canuck Buck Will Come Back to Earth

For the first time since 1976, the Canadian dollar is now trading at par-value versus its largest trading partner, the United States.
On Friday, the Canuck buck or loonie, closed at par-value vis-à-vis the U.S. dollar, meaning one Canadian dollar equaled one American dollar. The last time both currencies traded at par was in 1976. At the time, the secessionist Parti Quebecois was elected in Quebec and commodities prices were in the midst of a secular bull market.
And Canadians are definitely proud now that history is repeating itself.
The news media in Canada has taken the loonie's new flight by storm since last Friday. A newfound pride has erupted across a country which has been almost perpetually saddled with a weaker currency against its much larger American brother.
Since hitting a 125-year low in February 2002, the loonie has surged a cumulative 62% versus the sagging greenback. Meanwhile, the greenback is now in its sixth year of a secular bear market versus most foreign currencies and gold.
Watch the Loonie Fly
Canada Now a Petro-Currency
Since discovering bitumen or tar sands in Northern Alberta, Canada has become the world's second-largest source of untapped oil reserves after Saudi Arabia.
It's no surprise the Canadian dollar shadows the price of spot crude. On any given trading day, the loonie tracks the performance of West Texas intermediate crude oil, while the U.S. dollar is slammed by economic trends.
Indeed, Canada's energy exports have skyrocketed this decade amid declining global reserves and China's insatiable appetite for refined Canadian energy products and raw materials.
As a result, Canada's trade balance has been in a secular uptrend since 2002 while its fiscal performance has been the envy of international markets as tax receipts surge. Despite the country's enviable twin surpluses, both Liberal and Conservative governments have refused to meaningfully reduce the country's stifling tax burden, further bulging Canada's budget surpluses.
We Can Thank the Drowning Buck for the Flying Loonie
Since 2002, I've repeatedly predicted a par-value currency relationship between the world's two largest trading partners. Well, it's finally here.
The Canadian dollar has appreciated mainly because of a healthy balance sheet and booming commodities prices. But part of that currency gain can also be attributed to protracted U.S. dollar weakness. The American dollar has been in a virtual freefall over the last five years and has declined versus almost every currency in the world since 2002.
America's fiscal burden continues to drag down growth as a tirade of bearish developments encourages dollar-based selling. The ongoing mortgage-backed crisis, housing woes, the Iraq war and exorbitant budget and trade deficits are encouraging traders to dump the buck. Canada, on the other hand, has dramatically reduced its foreign debt over the last decade and continues to record trade surpluses almost every quarter.
But be careful. The soaring value of the Canadian dollar will exact a toll on Canada's economy - eventually.
Soaring Loonie Comes at a Price
A strong currency inhibits manufacturing exports as cheaper currencies in foreign markets compete to sell similar goods and services.
Canada does harbor a plethora of raw materials to feed and grow the world's emerging markets. But the country's non-commodity exports, including forestry, continue to bleed a slow death in 2007. The strong loonie is resulting in mounting manufacturing job losses, rising labor discontent and seriously damaging the country's export platforms in Ontario and Quebec.
So while Western Canada, loaded with natural resources, continues to benefit from the commodity bull market, the rest of the nation climbs deeper into a hole. The rest of the exporters are struggling with an expensive currency and the government's reluctance to cut tax rates. Business leaders have also increased the call to lower interest rates this year to suppress the loonie's value and alleviate manufacturing losses. Indeed, until the U.S. sub-prime crisis resurfaced in July, the Bank of Canada had been tightening or raising interest rates.
For now, Canada is enjoying a strong currency. It is the best-performing dollar-based unit in 2007. The Canuck buck is up 17% versus the U.S. dollar and even rising 8% versus the almighty euro.
But at some point over the next several months, I expect the loonie to finally head back to earth. I see a U.S. economic slowdown and easier Bank of Canada monetary policy clipping the loonie's wings. Never in Canada's history has it managed to defy a U.S. economic slowdown or recession.
The loonie has further to sail and will probably fetch a premium against the sagging greenback. But 12 months from now, I'll bet the Canadian dollar will buy less, not more, American dollars as the economy slows amid declining trade-flows between both markets.


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