When the loonie takes a dive

Fluctuations in the dollar mean good news for some and bad news for others.

For the past year, the Canadian dollar has been losing ground against its US counterpart. While Canadians had gotten used to parity, by the end of March, the loonie was worth about US90¢, a four-year low point.

Is this good news or bad news? The reality is that fluctuations in the dollar affect us in various ways. The tourism industry and exporters tend to benefit from a weak loonie, whereas importers, among others, will be hit hard. Even in manufacturing, the impact varies. A company that sells the majority of its goods in US dollars will see its profits rise, while another that buys much of its raw materials from the US will likely find itself on the losing end.

What about consumers? According to a recent Globe and Mail article, the loonie's decline should result in higher prices for some goods, such as groceries. Online purchases on US websites, such as eBay and Amazon, could also be more expensive.

A complex cause-and-effect relationship

The relationship between exchange rates and prices is not as clear cut as one might think. In an article on Macleans.ca, economist Mike Moffatt argues that Canadians benefited a great deal from the dollar's ascent in recent years, even if we didn't necessarily see lower prices at the register. What's more, the Bank of Canada's actions work to mitigate inflationary and deflationary pressures. So when the loonie rises relative to the greenback, buying US imports and crossborder shopping become more affordable. This increase in the Canadian dollar puts deflationary (or downward) pressure on domestic prices. The Bank of Canada, as Moffatt explains, responds by increasing the money supply to meet its inflation target.

Where does this growth in the money supply go? Moffatt claims that over the past 10 years, much of it has gone into the pockets of workers in the form of wage increases. Thus, instead of seeing lower prices, many of us have seen our earnings go up. In short, our purchasing power rises whenever the loonie ascends.

That's why I prefer a strong dollar to a weak one.

Dutch disease

Against this backdrop, now is a good time to debunk an enduring myth about the economic condition known as "Dutch disease." According to this theory, strong demand for natural resource exports (such as Alberta oil) lifted the dollar to the detriment of the Canadian manufacturing sector, which saw its goods become less competitive than foreign-produced products.

In a study published in January 2013, researcher Philip Cross of the Ottawa-based public policy think-tank Macdonald- Laurier Institute shows that the Dutch disease theory is flawed. Commodity prices, including oil, have accounted for less than half of the loonie's rise since 2002, Cross wrote in a column in the National Post.

As a matter of fact, the Bank of Canada attributes this increase largely to weakness in the US dollar.

The stronger Canadian dollar is not the source of all that ails manufacturing. To be sure, the loonie's rise has stifled some manufacturers. But others have benefited from the commodity boom, especially oil and metal mining companies. The stronger dollar has also made it easier for many manufacturers to buy equipment or pay less for their raw material.

The largest manufacturing losses were mainly in those sectors impacted by the troubled US automobile and housing industries and by Chinese competition in textiles not as a result of a strong dollar or Dutch disease.