Exchange Rate Explanation Canada vs US Dollar?!?

Is there a simple 1-sentence (or 1-paragraph) explanation as to why the Canadian Dollar varies opposite the US Dollar? Something like : “As US Economy Gets Stronger versus the Canadian Economy, the US Dollar is worth more Canadian Dollars” … Could it really be boiled down to that simple of an explanation??? (About 25 years ago the US and Canadian Dollars were pretty much on par … now it’s 1.60 Canada per US??? Has the Canadian economy “tanked” that much opposite the US’s economy? (not looking for a complex answer with economics and supply-demand economic theory - hopefully a simple one … [so I can explain it to my 10-year old daughter :-)]) Thanks! “SCT-Hockeytown”

I’ve never really understood the exchange rates, either. I recently began to buy DVD’s from England. When I started, the rate was about $1.43/£. Now it’s up to about $1.57. Of course, IIRC, the Pound was worth about $5 at one time (70’s?).

Because it’s not backed by the same government. It’s the Canadian Dollar, not the US Dollar. The Honk Kong Dollar has a different backer also and thus a different value.

I am a retired currency speculator so I can help but you have to be a bit more specific. Are you asking for the specifics of $/CD or of exchange rates in general? In either case you’ll need some economic theory. Are you really looking an answer for a 10 yr old or just a simple answer. I could give you some easy explanations of a few mechanisms that cause exchange rate fluctuations like interest rate and purchasing price parity that a 10 yr old could probably understand. Balance of Trade, safe haven, and other factors would be a little more difficult.

I think that “Safe Haven” is the operating explanation here. I just read that something like $1 Billion a day are still fleeing the rest of the world to the US. Every time someone brings Canadian dollars, Francs, Marks, Zlotys, whatever to the US, the price of US dollars rises and the currency that is sold falls. Let people lose confidence in the US dollar and you will see the USD fall faster than a stone in Pisa. Is this rational? Probably not.

I am always amazed how many things cost the same dollar amount in the US and Canada. It makes no sense, but it is true. This is most notable for simple things like shampoo where the price probably bears almost no relation to the actual cost of production, which may be almost negligeable.

First, just forget that both currencies called the “dollar.” It’s merely an accident of history that Canada and the US use the same name for their money. If it makes it any easier to understand, think of the currencies as two completely different things called the United States Buck and the Canadian Loony. :slight_smile:

The key thing to realize about foreign exchange rates is that they’re just a price. Prices change all the time–stock market prices, commodity market prices, prices at the supermarket. Foreign exchange prices are no exception.

The price of the Buck in terms of Loonies varies for all sorts of reasons, in response to changes in supply and demand for the currencies. Changes in the strength in the US economy vs. the Canadian economy are one component, as are differing government policies regarding the money supply and the interest rate.

A quick look 'round the Net suggests that a primary reason that the Loony has depreciated over the last couple of decades is that Canada is still fairly dependent on commodity exports. Canada is a net exporter of commodities (wood, gold, oil, that sort of thing) to the rest of the world. The US, by contrast, is a net importer of commodities from the rest of the world.

World commodity prices have taken a beating recently–and by “recently” I mean “the last twenty years.” As world commodity prices have fallen, so too has demand for the Canadian dollar, leading to a fall in its price–i.e. a depreciation in the Loony.

There’s a lot more to it then that, but then you did only ask for one paragraph!

To repeat: there’s no particular reason to think that $1 CDN will or should be equivalent to $1 US. They’re two totally different currencies that just happen to share a name. Hope this helps.

You could say “since the Napoleonic Wars” and nobody could prove you wrong.

But to get back to the OP … relative currency values will be based roughly on “Purchasing Power Parity” (PPP)

PPP does not provide a complete answer, however, for several major reasons:
[li]Difficulties in determining what, precisely, goes into the basket[/li][li]Costs of transportation (e.g., you can’t export real estate)[/li][li]Market expectations of future developments[/li][/ul]

For example, if inflation in country A with currency A is 10% while only 5% in country B with currency B, one would expect currency A to depreciate by 5% every year.

Also, societies adjust their buying behavior to get the most value for their money, which confuses the issue of what should be in the basket … people eat more lobster in Nova Scotia than Saskatchewan - how much lobster should be included in the shopping basket?

And then there’s the whole “safe haven” argument mentioned by KidCharlemagne and Hari Seldon. How do you put a price on safety of one’s savings? We can be reasonably sure in Canada that our bank accounts won’t be confiscated, but how much “should” an Argentinian peso have been worth two years ago?

Additionally, there’s the whole issue of marketting strategies by major multinationals … cars are much cheaper in Canada than they are in the US, simply because the manufacturers can make a marginal profit at the lower Canadian price and wouldn’t be able to sell nearly so many in Canada at the US price … which has, inevitably, led to a black market in cars bought in Canada for export to the States as the market’s “invisible hand” attempts to restore PPP, much to the chagrin of the automakers.

So PPP is a good place to start, but it requires many adjustments!

The value of the Loony vs. the greenback will vary daily for many reasons, among which are:
[li]Seasonal supply and demand. Many Canadian branches of US corporations will send the annual profits south in December; selling CAD and buying USD, with obvious effects on the rate[/li][li]Episodic supply and demand. One reason the loony was so high in the late '80’s was because the provinces, having tapped out the domestic market, issued bonds in US funds and sold these US funds for Canadian in order to spend them. Similar effects can be seen when there is a major cross-border corporate take-over.[/li][li]Interests rates, inflation and expectations thereof. An investor will seek to maximize his return, subject to constraints on risk. Increased business activity (a strong economy) will normally lead to higher interest rates without directly affecting the exchange rate. Therefore, you would prefer to buy currency A to purchase an investment yielding 5%, as opposed to a similar investment in currency B yielding 2%, as long as you can be reasonably sure that you won’t lose the increment on the future currency exchange. When you sell your B to buy A, this will have an effect on the price.[/li][li]Terms of Trade. To take things to a very simple level, what the States wants to do is buy from Canada a barrel of oil and give us a pocket-calculator in exchange. When the price of oil falls, they only need to give us half a pocket-calculator … but given that the barter is not direct (we can buy pocket calculators anywhere, and we might decide it would be better to buy three pairs of socks), the damage done to the economy by this shift in terms of trade is spread out by making the currency worth less … so they still pay us 30 loonies for the oil, and a pocket calculator still costs 20 greenbacks … but it now takes more than 30 loonies to buy 20 greenbacks.[/li][/ul]

One other factor that no-one has mentioned is the uncertainty caused by the threat of Quebec secession. Investors don’t like to invest money in places that might undergo political instability. Uncertainties over the possibility of secession contributed to the loonie’s nose dive in the nineties.

The trouble with Wumpus’s suggestion is that under traditional economic theory, a net exporter should see its currency rise since importers need its currency to buy those exports; a net importer should see its currency fall, since it has to sell its currency to buy those imports. Therefore it is necessary to explain why, over a period of over 25 years, the loony has continued to fall and the greenback has continued to rise. I stick to my explanation that it is essentially a big con game.

True commodity prices have been falling since before Napoleon. Since the first automation, in fact. I guess since the spinning wheel was invented, but net exporters should still see their currency rise in value and net importers should see it fall.

It’s not a ‘big con game’. It’s the currency market, which accurately reflects the value people place on the currencies.

The Canadian dollar used to be ‘pegged’ to the American dollar, meaning that it moved in price along with the U.S. dollar. And there was even a time when the Canadian dollar was worth more than the U.S. dollar. The fact that it has falled to 60x cents is nothing more than a reflection of the relative demand for the two currencies.

One big difference that partially caused the drop in the dollar from 80 cents down to 65 was a change in Canadian interest rate policy. For a long time, Canada’s interest rates were 2 or 3 percent higher than American interest rates. This was done intentionally by the Bank of Canada in order to prop up the dollar. A few years ago, the interest rate was allowed to drop to its more natural levels, and actually went below the interest rates in the U.S.