Friday, February 25, 2005

Currency

by StFerdIII

The value of a nation’s currency is dependent on a number of factors. Chiefly there are 4 main contributor’s in evaluating a currency's worth:

-Monetary and Fiscal policies of the domestic government[s] including; loose or tight money supply; budget deficits, unfunded liabilities and total aggregate debt
-Levels of taxation and regulation and rates of return from the domestic market vs. its main competitors
-Differential in interest rates between the country and other developed nations
-International trade components and the split between manufactured goods, services and raw materials
-GDP growth and Foreign Direct Investment [as a share of the world total]

With the C$ in the 80-82 US cents range it is apparent that the 30 year currency devaluation impaired Canadian business. Due to a low productivity level, lack of capital and technology investment and a desire to avoid business innovations, Canadian firms have relied on a cheap currency to compete. This is not a smart economic strategy. Unfortunately in the coming years the C$ will inevitably decline vis a vis the U$ due to a number of factors:

 

1.

Foreign Investment into the US will pick up [currently it is off 80 %] as investors realize the US economy is growing at 4 % per year.

 

2.

Canadian interest rates will come down thereby lessening the profit traders can make between the C$ and U$.

 

3.

US productivity which is 2x higher than Canada’s means more profits in the US and eventually more jobs, stimulating economic investment.

 

4.

Tax reductions in the US are already stimulating capital investments.

 

5.

US budget deficit will be eradicated through higher growth rates and spending reductions

 

6.

Price of oil will decline to the mid $30 range by 2006 thereby fuelling a sell off in the C$.

These factors ensure that the C$ in the long term will decline and in 2005 I would expect the C$ to reach about US 74 cents and in 2006, 68 cents.

Nevertheless Canadian firms must invest more in productivity and lobby harder to reduce tax and spend in Canada and create a regime that is more business friendly than in the US. Such a regime would stimulate jobs, pay for social programs and improve living standards. Canada should strive for a high dollar policy not a cheap export driven/interest group driven currency value.

A strong or weak currency affects national sovereignty, productivity and wealth. Floating or Fixed exchange rates are the 2 essential theories that help form the monetary regime. Currently politicians believe that the exchange should float because shocks to the Canadian and US economies are asymmetric (due to Canada's supposed dependency on natural resources). However this logic is flawed.

The industrial areas of Canada are net importers of natural resources whose business cycles are symmetric with the US'. International trade is 3x more important for the industrialized areas of Canada as a share of GDP than intra-Canadian trade. A fluctuating C$ and the transaction costs associated with it, are an impediment to our economic health. It is not outrageous that the rationale for EU monetary integration (at least its economic component), namely; a reduction in transaction costs, the symmetry of business cycles, the furtherance of foreign investment and the control of inflation could be applied equally with the same rationale to Canada and the US.

Once the C$ devalues expect the clamor for fixed exchange rates to rise.