Exchange RatesExchange rates are rates at which nations' currencies are exchanged, that is, the price of one currency in terms of another. A large number of countries now use the American dollar as the standard against which to measure the value of their own currency. As the great majority of Canada's international trade and financial transactions are with the US, the value of the Canadian dollar in relation to the US dollar is of prime importance to Canada.
The dollar became the official monetary unit of the Province of Canada on 1 January 1858 and the official currency of Canada after Confederation. Its "spot" or current market value has approximated the US$ until the former's recent decline, the significant exception being during the US Civil War, when the Canadian dollar rose to US$1.45. From 1879 to 1914 Canadian and American currencies were on the gold standard and were therefore each defined by fixed and equal units of gold.
Following World War I, except for the brief period between 1926 and 1929 when Canada returned to the gold standard, the Canadian dollar has been either pegged at a particular value in relation to the US dollar (1962-70) or allowed to fluctuate according to international demand and supply. From 1952 and 1962 and since 1970, the Canadian dollar has fluctuated or "floated." During these periods the BANK OF CANADA has bought and sold foreign exchange to smooth out daily fluctuations in the rate. It has also raised or lowered Canadian interest rates, relative to those in the US, to encourage or discourage funds flowing into Canada that increase or decrease the value of the Canadian dollar. Since being unpegged in 1970 the Canadian dollar has traded as high as US $ 1.04 in 1974 and reached a historic low of nearly US $0.63 in the summer of 1998.
The exchange rate of the Canadian dollar is influenced by numerous factors besides direct government exchange rate policy. Prosperous business conditions abroad, particularly in the US, containment of Canadian inflation, improved labour productivity, good grain harvests, new resource developments and expanded domestic and foreign direct investment in export-oriented industries all help to stimulate exports and put upward pressure on the dollar's foreign worth. An increase in foreign tourists visiting Canada has a similar effect. Conversely, the opposite of these forces places downward pressure on the dollar's external value. In addition, concerns about whether the province of Québec will remain in the Canadian federation tend to put downward pressure on the Canadian dollar.
By mid-1998 the economic turmoil and financial uncertainty in Russia and much of Asia raised fears about the strength of currencies of some developed countries like Canada. Canada exports significant amounts of resource-based products to Asian countries, which are now uncertain markets. As well, Russia, with its much-depreciated currency, is a competitor of Canada for many such products. Because of these negative factors, currency speculators have been moving funds out of Canada to the US in anticipation of a weaker Canadian dollar. Their own actions have caused their expectations to be realized, in spite of the Bank of Canada spending billions of dollars ($5.8 billion in August 1998 alone) buying up Canadian currency to try to reduce the extent of its depreciation in foreign exchange markets.
This lower dollar does, however, have benefits for Canadian firms exporting products to the US and elsewhere. Where such products are priced in US dollars, the revenues to Canadian firms, in terms of Canadian dollars, increase. Where the products are denominated in Canadian dollars, they become cheaper to foreign buyers, so more of them are sold. Either way, exporters benefit. But there are costs too. Canadians import products and services equivalent to nearly 40% of the total output of the economy (Gross Domestic Product), with about 76% of these being from the US. When the value of the Canadian dollar falls, all these products and services cost more for Canadians to buy. The lower dollar raises inflationary pressures, which may spread throughout the economy, even though the unemployment rate remains quite high.
The current downward pressure on the dollar has primarily been caused by intense speculation rather than major weaknesses in the Canadian economy. Because of this, the Bank of Canada responded by raising the Bank Rate by one per cent. Although this increase raises costs for borrowers, higher interest rates discourage capital flight from Canada and help to stabilize and even increase the value of the dollar. Once the speculation mania has subsided, it will be possible for the Bank Rate to be lowered again, thereby lowering the interest rate structure.