Learning to Live With a Strong Canadian Dollar: Four Options for Business and Government by Glen Hodgson. This briefing examines the implications of a strong currency for Canadian businesses and the Canadian economy, and it provides options and strategies for adapting to a strong currency. The Conference Board of Canada, 8 pages, April 2010.

1. Briefing April 2010
Learning to Live With a
Strong Canadian Dollar
Four Options for Business
and Government
T
he loonie is flying high once again. With the
at a Glance economic recovery starting to take hold, the
TheCanadiandollarisatparitywithitsU.S. Canadian dollar has settled in comfortably at
counterpart,anditislikelytoremainstrong parity with the U.S. dollar, and it is getting ready to
foralongtimetocome. soar even higher on occasion, once the global recovery
becomes more widespread and sustained. Will a soaring
Firmsmusttakeactiontoadapttolifewitha loonie finally provide the boost to productivity that
strongloonie—the“donothing”approachis Canadian firms need? Or will Canadian firms become a
notaviableoption. victim of a strong currency and contract “Dutch disease”?
Afloatingexchangeratepolicyremainsthe
bestpolicycourseforCanada. This briefing for The Conference Board of Canada’s
International Trade and Investment Centre examines the
Forfirmsthatareableandwillingtoadapt,a implications of a strong currency for Canadian businesses
strongCanadiandollarmaybejustthechal- and the Canadian economy, and it provides four options
lengethatunlocksaneweconomicpotential— and related strategies for adapting to a strong currency.
throughenhancedinnovation,fasterproductivity
growth,andexpandedinternationalization.
Trade, InvesTmenT PolIcy and InTernaTIonal cooPeraTIon

2. 2 | LearningtoLiveWithaStrongCanadianDollar—April2010
conTexT lIvInG WITh a sTronG canadIan
dollar: The oPTIons avaIlable
Over the past year, the Canadian dollar has moved
steadily higher, going from a floor of about 77 cents U.S. So how might firms operating in Canada respond to the
a year ago during the worst of the global economic reces- structural repositioning of the loonie? There are a range of
sion to just below parity with the U.S. dollar today. In available options, with wide variation in the implications.
fact, the loonie started to rise in value well ahead of Here are the four most likely choices:
the recovery in global and Canadian growth, propelled
by a rebound in commodity prices (particularly global 1. do noThInG
oil prices) and by Canada’s relative attractiveness as an The first option is both easy and extremely painful—do
investment destination. nothing. If Canadian firms (and the entire economy
for that matter) fail to respond to the upward structural
realignment of the Canadian dollar, they will slowly lose
canada’s solid banking system, solid domestic economy, their international competitiveness and eventually contract
relatively healthy fiscal situation, and wealth in raw what is called “Dutch disease.” Dutch disease is the loss
materials will continue to support a strong loonie. of international competitiveness due to a stronger currency
that is pushed upward by higher prices for key commodity
exports. In the case of the Netherlands, the guilder was
The loonie’s rise is also the flip-side of the downward pushed progressively higher during the 1960s and 1970s
slide in the value of other major currencies—the U.S. by the revenues from the sale of natural gas from reserves
greenback, the British pound, and more recently, the in the North Sea. A rising guilder gradually eroded the
euro. Global currency markets are highly volatile right competitiveness of Dutch manufacturing, which did not
now due to the deep uncertainty that exists in many adapt quickly enough to the new exchange rate reality—
major economies. The U.S. economic recovery is still hence the name “Dutch disease.”
not fully assured. The financial crisis and recession has
taken a heavy toll on the British economy and on the
pound. And recent events within the euro zone, such as “doing nothing” is not a desirable or realistic scenario
the fiscal tragedies in Greece and Portugal, are raising for canadian businesses or the economy as a whole.
questions about the credibility of the euro. As a conse-
quence, investments in the Canadian dollar look awfully
good compared with investments denominated in many The conditions for Dutch disease are already occurring in
other currencies. Canada. The issue is whether firms will adapt, or contract
the disease and potentially expire. If firms do nothing,
For the foreseeable future, Canada’s solid banking system, there is much greater risk of contracting a serious case
solid domestic economy, relatively healthy fiscal situation, of Dutch disease. Therefore, doing nothing is not a
and wealth in raw materials (especially oil) will continue desirable or realistic scenario for Canadian businesses
to support a strong loonie. These fundamentals suggest or the economy as a whole, and it should be set aside
that the Canadian dollar will remain roughly at parity with as a credible option.
the greenback over the near term. Moreover, the loonie
could be pushed beyond par by factors such as a sharp 2. adoPT a FIxed exchanGe raTe
rise in oil prices or a period of positive interest rate A second option would be to consider a fundamental
differentials. In short, the signs point to continued change in Canada’s exchange rate policy, specifically by
strength in the Canadian dollar for some time to come. adopting a fixed exchange rate policy through pegging
the loonie to the U.S. dollar. In recent years, the idea of
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3. TheConferenceBoardofCanada | 3
fixing the loonie to the U.S. dollar has been raised with reached in 2002 when the Canadian dollar fell to 62 cents?
the Conference Board by numerous people in business, Presumably it isn’t the top of the trading range for the
and by a few in public policy. Some Canadian economists loonie, which briefly traded at US$1.10 in 2008. Or should
and media commentators have argued that Canadians a fixed rate fall somewhere in between, such as the point
would be better off if the country adopted a fixed where analysts think that purchasing power in the U.S. and
exchange rate policy.1 Canada is equalized—which is probably around 85 cents?
Under this line of argument, the Canadian dollar would The level at which the exchange rate is fixed would be
be pegged against its U.S. counterpart, thus effectively critical. There are economic winners and losers at any
removing currency fluctuations from decision making by exchange rate level, and the gains or losses would be
businesses and consumers. Alternative ideas, such as a long-lasting under a fixed exchange rate system. For
target exchange rate within a trading band, have also been example, exporters with high Canadian costs and a low
raised. A more extreme arrangement would see the loonie level of imports in their production process might prefer
disappear and the U.S. greenback adopted as Canada’s a pegged rate below 70 cents. Firms with a high import
currency, either unilaterally or under a full monetary content in their production process would favour a
union, similar to what has occurred under the euro zone. stronger currency, as would heavy consumers of imported
goods. At the extreme, Canadians on vacation in Florida
or Arizona, not to mention professional sports franchises
some economists have argued that canadians would be based in Canada with revenues in Canadian dollars and
better off if a fixed exchange rate policy was adopted. U.S. dollar salaries for players, would love a pegged
rate above US$1.00.
Advocates of a fixed exchange rate policy emphasize the
potential benefits of exchange rate stability. It is argued advocates of a fixed exchange rate policy emphasize the
that a fixed exchange rate with our dominant trade and potential benefits of exchange rate stability.
investment partner—the United States—would help to
maintain our international competitiveness. Stable prices
would be established for the majority of Canada’s traded The second critical issue is the impact of a fixed exchange
goods and services, and for much of our international rate on Canadian monetary policy. If we decided to peg
investment. However, the advocates of such a system the loonie to the U.S. dollar, we essentially would be
seldom give sufficient weight to the thorny economic eliminating the Bank of Canada’s latitude to establish an
policy and political decisions that would arise if we independent monetary policy for Canada. The Bank would
were to implement, and then try to maintain, a fixed have to follow the interest rate path determined by the U.S.
exchange rate policy. Federal Reserve Board in order to maintain the pegged
exchange rate. Tight controls on international capital flows
Three policy issues are of critical importance. First, we would be required in order to manage the movement of
would have to select the “right” exchange rate for pegging investment funds in and out of the country, since these
ourselves to the U.S. dollar. Is the “right” exchange rate movements influence the exchange rate. Of course, inter-
at the bottom of the historical trading range, which we national capital controls would cause other problems—
such as creating a barrier to increased investment, both
within Canada and offshore, by Canadian firms seeking
1 SeeThomasCourchene,“Canada’sFloatingRateNeedsFixing,”
Policy Options(February2008),pp.24–28;orNeilReynolds, to globalize their business.
“DollarWoes:AMonetaryUnionSolution,”The Globe and Mail
(November16,2007),p.B2.
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4. 4 | LearningtoLiveWithaStrongCanadianDollar—April2010
U.S. monetary policy is determined by U.S. economic shock—which could make for very difficult politics.
conditions, not by conditions here in Canada. Without And the political elephant in the room would be the
the establishment of a common currency area, it is highly potential—some might say the inevitable—erosion of
improbable that Canada would have a direct role in the Canadian political sovereignty if we were to peg the
Fed’s decision making; and the Canadian tail would Canadian dollar to the greenback.
be unable to wag the American dog when it came to
a common monetary policy. The bottom line on exchange rate policy is that Canada
has chosen to allow the exchange rate to float and adjust
Third, and perhaps most importantly, under a pegged to global forces. When global growth has weakened and
exchange rate, any external shocks or imbalances would commodity prices have fallen, the exchange rate has acted
need to be addressed by purely domestic adjustments in as a shock absorber—falling and thereby cushioning the
fiscal policy and in wages. The exchange rate could no impact on revenues and income. When commodity prices
longer be used to offset external shocks. and economic growth have been strong, the Canadian
dollar has risen in value—as is the case today. The cur-
rent system has served Canada well for many decades,
When commodity prices and economic growth have been notwithstanding the need to adapt to sharp exchange rate
strong, the canadian dollar has risen in value. movements and structural shifts—also the case today.
A floating exchange rate policy remains the best policy
course for Canada, and the fixed exchange rate option
A recent sharp external shock illustrates the point. should also be set aside. Like the “do nothing” option, a
Commodity prices collapsed in the fall of 2008 as a fixed exchange rate is not a desirable or realistic scenario
result of the financial crisis. If Canada had been under for Canadian businesses or the economy.
a fixed exchange rate regime at that time, it would have
had to cut wages and public spending in order to adjust
to the external shock and rebalance the country’s exter- Under a pegged exchange rate, any external shocks or
nal accounts. But under the existing floating currency balances would need to be addressed by purely domestic
system, the exchange rate took the hit from a collapse adjustments in fiscal policy and in wages.
in commodity prices, and the Canadian dollar drifted
down to around 80 cents.
3. boosT ProdUcTIvITy GroWTh
The natural reluctance of business leaders and ordinary The third and fourth options are challenging for businesses,
citizens to be required to adjust domestic wages and but also create the potential for significant rewards over
government spending in order to re-stabilize the external the long term.
accounts is one key reason why most countries have
moved away from a fixed exchange rate policy over The third option calls for Canadian firms to respond to the
the past 30 years. Recent events within the euro zone, structural shift upward in the loonie by becoming more
for example, provide more real-time illustrations of the productive and efficient. They would seek out ways to re-
challenges of implementing domestic economic policy invent themselves, re-structure their operations globally,
within a fixed exchange rate system. and create an internal culture of innovation that feeds
stronger productivity growth. Firms would no longer be
Then there are the politics of a fixed exchange rate able to rely on a cheap dollar for their competitiveness;
system. As noted, increases or decreases in public they would have to increase their productivity through
spending would be required to adjust to an external improved innovation, or risk contraction—even extinction.
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5. TheConferenceBoardofCanada | 5
Most economists would agree that a strong Canadian
dollar should act as a catalyst for stronger productivity chart 1
growth. A strong loonie makes imported goods—includ- LabourProductivityGrowth
(percent)
ing imported technology that can help firms become more
efficient—cheaper. But things are seldom that simple or Canada U.S.
linear in the real world. As but one example of this, the 2.0
Canadian national accounts data for the fourth quarter of 1.8
2009 indicated that investment in machinery and equip- 1.6
1.4
ment, much of which is imported, actually fell by 2.4 per 1.2
cent even as the dollar was rising in value. We suspect 1.0
that this was an aberration that will be corrected over 0.8
0.6
the coming quarters, but it does suggest that a strong 0.4
currency and the resulting lower import prices may 1970s 1980s 1990s 2000s
not be sufficient on their own to produce a sustained
improvement in Canada’s productivity performance. Source:TheConferenceBoardofCanada.
most economists would agree that a strong canadian dollar re-energizing free trade and investment within north
should act as a catalyst for stronger productivity growth. america and globally. (The recent Conference Board
report Re-Energizing Canada’s International Trade:
Strategies for Post-Recession Success2 provides
For many years now, The Conference Board of Canada detailed analysis and guidance on how to strengthen
has advised firms and governments to develop and imple- trade policy and strategy.)
ment a strategic plan to improve Canada’s dismal track
record on productivity growth. (See Chart 1.) There is Action on all these fronts should be supported by
no silver bullet for “fixing” productivity, but action on a adopting a culture of innovation within Canadian
number of fronts should contribute to better performance organizations—one in which new ideas and measured
by firms and by the entire economy. These include: risk-taking are encouraged. There are many competing
Fostering stronger investment in physical capital. Recent definitions for innovation, but in the simplest terms,
tax reform—such as the elimination of federal and innovation is making changes—both big and small—
some provincial capital taxes, and lower corporate that create value. These changes can lead to increased
income tax rates—should create better incentives productivity, improved efficiency, or the launching of
for capital investment. new initiatives, thereby creating value by increasing
deepening canada’s human capital through increased profits for firms or strengthening the financial capacity
investment in people. Renewed public investment in of public sector organizations. In an ever-more integrated
education by governments, but also enhanced training and competitive global economy, innovation will be
and development by private firms, would contribute the factor that separates mediocre from good, and good
to human capital development in Canada. from great.
reducing barriers across the economy and improving
the alignment of regulations. Some progress has been Implementing a strategic plan to improve productivity
made on this front in recent years—such as the Trade, growth (see Exhibit 1) will be a critical part of adapting
Investment, and Labour Mobility Agreement (TILMA) to a strong loonie.
between Alberta and British Columbia, and improved
regulatory alignment between different levels of gov-
ernment on environmental assessments of projects— 2 TheConferenceBoardofCanada,Re-Energizing Canada’s
International Trade: Strategies for Post-Recession Success
but this remains an unfinished agenda. (Ottawa:Author,2010).
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6. 6 | LearningtoLiveWithaStrongCanadianDollar—April2010
against currency fluctuations within their overall oper-
exhibit 1 ations. The reason is that firms that are highly “internation-
Productivity:AConceptualPolicyFramework alized” are likely to have more flexibility in their operating
structures. In general, manufacturing industries, as well as
mining and oil and gas extraction industries, are the most
broadly internationalized—and firms in these industries
are therefore likely to have an operational hedging strategy
built into their business model.
Skills/Human Innovation
capital In contrast, service industries may be more exposed to cur-
rency volatility since they have fewer means within their
Investment
tio operations of hedging against dollar volatility. Industries
me
nt
Na
n al
o p e r a ti n g e n v i r o n that are highly reliant on foreign markets and suppliers,
in cl
u d i n g i n fr a s tr u c t u r e as well as those with limited strategies for doing business
N ort
h A m e ri c a n i n t e g r a ti o n in international markets, are not as well positioned to
Inter respond to fluctuations in the exchange rate.
n a ti o n a l ent
tr a d e a n d in v e st m
Dollar Volatility: Who Should Care? used four indica-
Source:TheConferenceBoardofCanada. tors to identify the degree to which 27 industries rely on
international transactions to conduct business, and the
nature of that internationalization. The four indicators
4. exPand The InTernaTIonalIzaTIon were: export intensity, import intensity of inputs, import
oF canadIan bUsInesses intensity of machinery and equipment investment, and
Option four is closely interlinked with option three, the extent of Canadian direct investment abroad. High
and would see more Canadian firms embrace various rankings on multiple indicators indicated a high level of
forms of engagement in international business in order internationalization for the manufacturing, mining, and
to be competitive. oil and gas extraction industries. (The report provides the
industry sector analysis in detail.)
Rapid movements in the exchange rate have made it
increasingly difficult for some businesses to develop a
workable cost structure. A recent 2010 Conference Board service industries may be more exposed to currency
report Dollar Volatility: Who Should Care?3 identified volatility because they have fewer means within their
the industries that are most and least exposed to rapid operation of hedging against dollar volatility.
changes in the value of the currency, such as we have
seen the past two years. The report provided some
surprising insights. The implication of this research is that Canadian
industries must continue to internationalize in order to
The conventional view is that manufacturers were more remain competitive. A firm that uses various approaches
highly exposed to currency fluctuation, since they rely to globalization simultaneously will be better positioned
more on exports than do other industrial sectors. But to reduce the financial risks associated with changes in
the Conference Board’s finding was that manufacturing the value of the Canadian dollar, and with the strong
industries, along with the mining and oil and gas extrac- dollar we see today.
tion industries, are the most able to weather a volatile
Canadian dollar because they have more ways to hedge Businesses, particularly small and medium-sized enter-
prises, need to examine where they fit into global supply
3 ValériePoulinandLouisThériault,Dollar Volatility: Who Should chains and to identify risks and opportunities in the
Care?(Ottawa:TheConferenceBoardofCanada,2010). international marketplace. Internationalizing also means
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7. TheConferenceBoardofCanada | 7
forming strategic partnerships with other firms and indus- Canadian businesses will have to come to grips with this
tries to share resources, risk, expertise, and capital in new reality. Ignoring the problem, or implementing quick
foreign markets. Policy makers can undertake indirect fixes, won’t work. While we have set out four options for
measures to prepare for and mitigate exchange rate effects adjusting to a strong loonie, in truth only two interrelated
on Canadian industries. These measures include increasing strategies will work—boosting productivity within firms
trade liberalization and renewing policies that encourage and across the economy, and expanding the international-
both inward and outbound foreign direct investment. ization of Canadian businesses.
Canadian firms are now being exposed to the Dutch
Policy makers can undertake indirect measures to mitigate disease virus. Some firms will not be able to adapt
exchange rate effects on canadian industries. quickly enough to the upward shift in the loonie, just
as some firms were unable to adapt to earlier structural
changes (such as the Free Trade Agreement, or much
higher energy and commodity prices). These firms will
conclUsIon fall prey and could well succumb to Dutch disease.
Driven higher by the still modest economic recovery, But for firms that are able and willing to adapt, a strong
the Canadian dollar is now at par with the U.S. dollar, and Canadian dollar may be just the challenge that unlocks
it could soar further once the global recovery becomes a new economic potential—through enhanced innovation,
more widespread and sustained. Our view is that the faster productivity growth, and expanded international-
Canadian dollar will remain a strong currency for some ization of their business strategy and operations.
time to come.
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8. acknowledgements
author Internal reviewers external reviewer
Glen Hodgson Louis Thériault and Danielle Goldfarb Christopher Ragan
The Conference Board of Canada would like to thank external reviewer Christopher Ragan of the federal Department of Finance and McGill
University, for his comments and suggestions, which were offered in his personal capacity and do not necessarily represent the views of his
organization. Any errors of fact or interpretation are solely the responsibility of the author and The Conference Board of Canada.
InTernaTIonal Trade and InvesTmenT cenTre members
The Conference Board of Canada is also grateful to the champion and lead members of the International Trade and Investment Centre
who, through their membership, support the Centre’s research program.1
aboUT The InTernaTIonal Trade and InvesTmenT cenTre
The International Trade and Investment Centre aims to help Canadian leaders better understand what global economic dynamics—such as
global and regional supply chains—mean for public policies and business strategies. The Centre brings together business and government
leaders in an off-the-record forum to discuss successful trade and investment strategies. The Centre’s independent, evidence-based reports
propose effective policy and business solutions for improving Canada’s trade and investment performance.
champion members Business Development Bank of Canada Natural Resources Canada
Export Development Canada Canada Economic Development Ontario Ministry of Economic
Foreign Affairs and International Canada Mortgage and Housing Corporation Development and Trade
Trade Canada Farm Credit Canada RBC Financial Group
Forest Products Association of Canada Sun Life Financial Inc.
lead members Industry Canada
Alberta International and Ministère du Développement
Intergovernmental Relations économique, de l’Innovation
et de l’Exportation du Québec
For more InFormaTIon
Please visit www.conferenceboard.ca/ITIC.
1 Theseorganizationsdonotnecessarilyendorsetheresearchconclusionsofthispaper.

9. Learning to Live With a Strong Canadian Dollar: Four Options for Business and Government
by Glen Hodgson
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