Impact of US Dollar on Canadian Economy Essay Example for Free

Impact of US Dollar on Canadian Economy Essay The Canadian Economy is strong. According to the 2001 Canada Yearbook, factors contributing to the country’s economic health are: natural resources; manufacturing and construction industries; financial and service sectors; the ability to span distances using communications and transportation technologies; dynamic trade relationships with other nations; and the ability to compete in a global marketplace (2004). Being the 2nd largest country in the world, Canada’s natural resources accounts for 12. 6% of its GDP growth in 2003. The Energy Sector, Forestry, Mineral Sector as well as Geomatics Sciences are responsible for this growth. Exportation of natural gas, timber and wood products, potash, uranium and other minerals make up for the growth. Geomatics is the science and technology of gathering, analyzing, interpreting, distributing and using geographic information. Since 2002, when the Canadian Government initiated the focus on understanding and mapping its land resources, it became one of the leading suppliers of information, technology and equipment in Geomatics. Today, Geomatics is a $10 to $20 billion dollar industry growing at a 20% rate, and thus is a potential growth area for the Canadian natural resources sector. According to Industry Canada, the Manufacturing and Construction Industries contribute to about 40% of Canada’s GDP, with an actual gross approximately $25 billion in December 2005. The two industries combined showed growth near single digit levels, (manufacturing at 1% GDP and construction at 0. 7% in Dec. 2005) which propelled the 0. 4 over-all GDP, making up for the loss in the Agriculture section at -1. 6% GDP in December 2005 (2006). The services sector in general is boosting the economy. Canada Yearbook states that the sector employs three out of four Canadians in the 21st Century (2004). Though their output is not as tangible as manufactured or natural goods, the services sector is everywhere and serve as the backbone of every economic sector. From the driver of a courier van to the company financial analyst to the service providers in Civil Defense, all the roles belong to the services sector. Together with advances in information technology, the services sector is transforming Canadian Economy into a knowledge-based economy (2006), as claimed by the Canadian Yearbook, where-in its modern products are efficient back-end services, professional consultancy and breakthrough technologies and equipment. Despite the economic transformation, trade is still the main means of business for Canada. As such, relationships with trade partners play a vital role. Among the countries in the world, four markets are in constant and significant trade relations with Canada: United States, United Kingdom, Japan and more recently, China. Among the four, its close neighbor, the United States takes about 75 – 80% of Canada’s trading business. Thus, changes in the Unites States economy, particularly of the US dollar impacts Canadian economy. State of Canada-US Trade Geography and history have provided opportunities for the United States and Canada to be in close business relations. In the natural order of things, free trade between the two nations would be beneficial in toto. However, political and social ramifications have prevented the successful pact since the mid 1800s until such time when, despite the disagreement of Canada’s Conservative Party, the Free Trade Agreement (FTA) between US and Canada was effected in October of 1987. The over-all provision is to minimize tariffs of all goods traded between the two countries to a maximum of 1%. With the FTA in effect, trade between the two countries rose to 40% from a pre-FTA level of 25%. However, there is strong opposition from Canada about violations of the United States in the provisions of FTA, to the disadvantage of Canada’s agricultural business. However, seeing the benefits of a free trade zone, Prime Minister elect Jean Chretien improved the FTA and broadened the extend of the free trade to Mexico. Thus, in January of 1994, the North American Free Trade Agreement (NAFTA) between the United States, Canada and Mexico, took effect. Such Agreement involves an immediate and phased release of tariffs and trade barriers for agricultural products traded between the three countries. A macro benefit of NAFTA is a systematic conduct of business within North America because of the creation of an impartial, rules-based system to resolve dispute among the countries. Significant increases in trade activity were observed among the three countries in the first seven years of NAFTA implementation as compared to agricultural trade activities with other markets outside of North America. Canadian agricultural and agri-food exports to the United States and Mexico have increased by 95 percent, reaching $14. 8 billion in 2000. In comparison, Canadian exports of agricultural products to non-NAFTA countries grew by 45 percent during the same period, according to Agriculture and Agri-food Department of Canada (2006). Prior to NAFTA, agricultural import-export activities between Canada and the United States was only at $13. 7 billion. However, this increased $25. 1 billion in 2000, 82% higher, since 1993. Because 61% of Canada’s farming produce are exported to the United States, agricultural exports for the same period grew 92% to reach $14. 1 billion. As a result, Canadas agricultural trade surplus with the United States has more than tripled since 1993. As summarized by the Agricultural Department of Canada, Horticultural crops: volume exports of tomatoes increased twenty-fold while exports of peppers and lettuce increased seven-fold, and exports of cucumbers increased six-fold. Oilseeds products: soybean oil volume exports increased seven-fold, exports of sunflower oil quadrupled, and canola oil exports increased by 44 percent. Specialty crops: dried beans volume exports nearly tripled. Red meats: beef volume exports more than doubled while pork exports increased by 87 percent. Processed products: roasted coffee volume exports increased nearly seventeen-fold, malt exports increased nearly five-fold, exports of frozen French fries increased four-fold, and pasta exports more than tripled. Following the success of NAFTA and its predecessors from other continents of the world, Canada together with thirty-three other countries belonging to the American Continent are drafting a free trade agreement called Free Trade Agreement Among the Americas (FTAA). With its complex participation, the agreement is still under negotiations. Factors that Influence the Rise of the Canadian Dollar (against the US Dollar) With the rise of the United States as an Economic super power, it naturally assumed a role of having the US dollar as a worldwide currency. Significant markets such as Canada are always compared to the dollar. Moreover, being a majority trade partner of the US, the exchange rate of the Canadian dollar matters significantly over the US dollar. Since 2003, Statistics Canada has plotted the rise of the Canadian dollar against the US dollar and indicated its significant rise against the greenback. There are three factors that may have contributed to this growth: first, the weakening of the US economy brought about by increasing current account deficits; secondly, the worldwide increase in commodity prices; and thirdly, the improved performance of the Canadian economy resulting in trade surplus. Since 2001, there has been a common phenomenon in most major currencies in the world: they appreciated against the US dollar. The Euro and Canadian dollar were two of the strongest performers. When the Euro surpassed the greenback in 2003 analysts predicted that there was no turning back. While the loonie has seen significant appreciation at the rate of 25% since 2001 until 2005, surpassing historical performance by the US dollar. Such appreciation has been driven by the increasing trade deficits of the US. Since 2001, the US has been buying more goods and a service than the country is able to sell. More oil, gas, metals and services were bought with US dollars than were sold outside of the US. Some analysts believe that the on-going War on Terror has been the main source of the deficit. While the country is still figuring out how to address the deficits, major trade partners such as Canada are reaping the benefits of a weakening dollar. At the mercy (or because) of commodity supply, the Canadian economy remained resilient despite the volatility of oil, gas, metals and wood. Being a major supplier of such commodities, precarious world prices came at an advantage. Despite some internal losses as a crude oil refiner, the bottom line effect of this factor remained positive and contributed to GDP. Thus, the increase of the Canadian dollar. Last factor that weakened the dollar from Canada’s point of view is the initiative of its government to attract more businesses through higher interest rates (vs. that of the United States). The over-all effect therefore, of the three factors above is the weakening of the US dollar against the Canadian dollar. Today, the exchange rate of the Canadian dollar is rising and reaching its peak in 2001, at C$ 0. 846 vs. the US$. With such growth, the general assessment of Canadian economists, businesses and external analysts is that this is positive for the Canadian economy, now more than ever. The next sections will have full discussion of the different sectors in the Canadian economy as impacted by the weakening (or strength) of the US dollar. Impact of the US Dollar on Canadian Industries Exports Apart from agriculture and agri-products, steel is another commodity that Canada heavily trades with the United States. Canada’s steel production accounts for approximately two percent of the world’s total supply. This is very small as compared to the Asian producers (Japan, North Korea and Taiwan), which accounts for nearly 40%. Nevertheless, 89% of Canada’s steel export go to the United States while 58% of Canada’s imported steel come from the US. Trade barriers, transportation costs prevent small Canadian steel producers from competing outside of North America. North America’s open market is ideal for small and big steel manufacturers from Canada. Just by its size and high demand, the opportunity for supply is wide. In addition, proximity to such a large market allows for low transportation cost. Just-in-time supply is immediately served without much impact on delivery cost. Furthermore, inventory can be kept low unless preparing for construction peak. Steel pricing in North America is also higher than other export markets by as much as 40% when compared to Japan, where steel importation is minimal due to its own supply. In North America, particularly the United States, steel trade is predicted to continue growth. In this light, sustained and open access to the U. S. market is key to the Canadian steel industry. A slight fallback in the market, for example, experienced in 1995 posed a threat to the industry. Whenever such a slow-down happens, issues related to anti-dumping and government subsidies arise, without any proper venue for address under NAFTA. Unfair trade practice is an issue commonly raised by the US against Canada when market conditions appear to favor Canada’s steel industry. In the same manner, weakening of the US dollar may initiate such a condition when Canada’s steel industry continues to maintain a surplus against the US. Once again is likely to be subject to charges of unfair trading practices by U. S. steelmakers. In 1993, according to Industry Canada, the country had a global steel trade surplus of $580 million and a steel trade surplus with the U. S. of $909 million. While the trade surplus was maintained with the U. S. , the surge in steel demand in 1994 resulted in a dramatic rise in imports and produced an overall international trade deficit of $207 million. The total trade balance deficit increased in 1995 to $349 million as Canadian imports again exceeded exports. However, the steel trade surplus with the U. S. was $1. 0 billion in 1995. Over the period from 1989 to 1995, steel imports have increased from 18. 6 percent of apparent domestic consumption in Canada to 29. 9 percent in 1995. Meanwhile the import share held by the U. S. increased from 8. 6 percent to 17. 5 percent. In the U. S. market, imports increased from 17. 9 percent of apparent domestic consumption in 1989 to 21. 4 percent in 1995, with Canadas import share increasing from 3. 1 percent to 4. 0 percent. With such steel trade dynamics between the two countries, the weakening of the US dollar means the increase in Canada’s export price. Either more US dollars are needed to purchase the same Canadian product in the 21st century, than during the slump 1990s; or less Canadian dollars are earned for every sale of a Canadian export. At the other end, when Canada imports from the US, the commodities and services become cheaper. Either way, both impacts sales and profits. When sales and profits are volatile, vulnerable small businesses tend to closedown and contribute to unemployment. In order to maintain profit margins, Canadian export companies will need to improve efficiencies. Improvement may come in three ways: production streamlining, outsourcing and amortization gains. When the US dollar is low, it is the best time for companies to reevaluate tools and machinery throughput. Technology improvements will present more-efficient, more-automated processes, which can be useful in improving production efficiency. Since most equipment are bought from the US or are priced in US dollars, lower dollar exchange rates mean cheaper equipment. This is one way that exports companies to maintain profit margins by reducing production cost through efficient machines. In the same line of thinking importing services also come cheaper than when the US dollar is strong. Whether obtaining services from the US, or from East Asia, where intelligent and skilled labor is cheap, outsourcing back-end process in export production always contribute to efficiency. Though this may result to redundancies, macro effects of outsourcing prove to be positive to the bottom line. Lastly, for businesses that amortize US dollar-denominated loans, there will be gains in the amortization payment because of the weakened dollar. Furthermore, during a round-table public forum in 2004, businessmen have suggested that the Canadian government consider lowering interests rates to match that of the US. Doing so will minimize the impact of loans on Canadian dollar-based denominations despite its appreciation. Imports The stronger currency benefits importers. Consumers and businesses benefit from a better Canada-U. S. exchange rate through less expensive imports from the U. S. The depreciation of the dollar lowers import costs and, more specifically, offers cheaper capital goods, making investment in new machinery and equipment in Canada cheaper. Canadian businesses import 80% of equipment and machinery, and with these imports now more affordable, a boost to business investment can be expected. However, some argue that with the loss of revenue, investments in new machinery and equipment would not be substantial.