Canadian Dollar
The Canadian dollar (CAD) is the national currency of Canada and is recognized for its strong value relative to other currencies globally. Established in the 1800s, the CAD evolved from the Canadian pound and gained significance due to the robustness of the Canadian financial system. This system's development has been influenced by a blend of English and Scottish heritage, improving its governance and structure over time. Notably, Canada successfully navigated the 2008 financial crisis without the widespread bank failures seen in the United States, highlighting the stability afforded by its financial regulations. The Canadian dollar is often referred to as a commodity currency, as its value is significantly impacted by global energy prices, particularly oil and natural gas. However, there is ongoing debate among economists regarding the strength and consistency of the relationship between commodity prices and the CAD's exchange rate. Additionally, the appreciation of the Canadian dollar can pose challenges for domestic firms, particularly in competitive markets, affecting their pricing and profitability. Overall, the Canadian dollar serves as a critical indicator of Canada’s economic health and is influenced by both domestic policies and international commodity markets.
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Canadian Dollar
Canada’s currency, the Canadian dollar, holds one of the strongest values of the world’s existing currencies. Originally instituted in the 1800s as the Canadian pound, the Canadian dollar and its strength can be attributed to the associated vitality of the Canadian financial system, which has evolved over the decades to not only reflect the changing structural needs of major industries and firms within the country, but also to safeguard the country as a whole from international financial shocks, unlike what occurred in the early 2000s with Canada’s neighbor, the United States. As a result, economists noted that industry and firms, particularly the banking sector, were all but unaffected by the 2008 financial crisis, propelling Canada and its commodity-based currency (the Canadian dollar) to the top of the list of economically viable countries after the crisis, due largely in part to the structure and governance of the financial system.
Brief History
The state of the financial system in Canada, and perhaps the biggest contributing factor to why the Canadian dollar has been strong for so long, is the result of a combination of structure and governance. With roots in English and Scottish heritage, the Canadian financial system is an amalgamation of cultures that dates back to the nineteenth century, with the Canadian dollar coming into existence in 1867. Although the Bank of Canada Act (1934), which was put in place under the guise that it would be revised every ten years to ensure timeliness, provided legislative guidance, it was not until the establishment of several Royal Commissions that the banking and insurance industries were fine-tuned to address potential weaknesses and opportunities: a key step in safeguarding. Additional significant financial institutions came about thereafter as part of a natural evolutionary process.
Moreover, an apparent lack of obstacles in establishing and executing Canada’s financial system—a lack of state or local legislation impeding the system and Canada’s smaller population versus land-area ratio—arguably allowed Canada to have more privately owned, publicly regulated institutions than the United States. However, the Canadian dollar’s success may also be the result of economic tactics employed by the country to survive the Great Depression of the 1930s, leading to the modern structure and resulting strength.
Although Canada is very similar to the United States and often compared to its more populous neighbor, Canada has maintained more economic stability in recent times. Specifically, during the economic and financial crisis that occurred between 2007 and 2009, Canada remained relatively unscathed by bank failures and similar financial crises that the United States experienced. Despite financial connections and economic integration with the United States, Canada experienced no similar mortgage defaults nor government interventions or bailouts. It is because of Canada’s significant difference in structure and governance of its financial system that the country and, subsequently, the Canadian dollar remained strong through the international crisis.
In 2018, the Canadian Parliament amended the Bank of Canada Act and the Currency Act to allow the Bank of Canada to make changes to the legal tender in circulation. On January 1, 2021, every series of the $1, $2, $25, $500, and $1,000 bills issued by the Royal Canadian Mint from 1935 to 1986 were no longer legal tender. These included the Bilingual series, Canadian Landscape series, Scenes of Canada series, and Birds of Canada series. Though no longer considered official legal tender, they could be exchanged for other bills at any Bank of Canada.
Overview
In an examination of a surge in energy prices, mainly for oil and natural gas, many analysts have revealed a relationship between the appreciation of the Canadian dollar and the rise in energy prices. This has been particularly true since 2003, and, thus, the Canadian dollar is also viewed as a commodity currency, which means the external value is often dictated and/or impacted by global commodity-related prices. Despite long-term recognition of the impact of commodity prices on the Canadian exchange by many analysts, using structural models, reduced-form structural models, and single-equation models, there are some economists who are not convinced the Canadian dollar is, in fact, a commodity currency. Reasons for support of the nonexistent relationship include studies that have examined the 1970s and the 1990s, both of which showed a decline in the relationship between commodity prices and exchange rate movements.
Additionally, it has been suggested that while a long-term relationship between commodity prices and exchange rates may be evident in Canada, this may be the result of controlled conditions, as opposed to a randomly determined one. Lastly, some analysts have found flaws in the seminal Bank of Canada exchange-rate equation because it was developed under the assumption that higher energy prices cause a depreciation of the Canadian dollar. This suggests the exact opposite of what one might assume, that is, an appreciation in the Canadian dollar as energy prices rise, given Canada’s position as a net energy exporter.
Finally, a discussion about the Canadian dollar is not complete without mentioning its impact on companies in Canada. Specifically, the impact of trade liberalization, which is the removal of barriers to allow for the free exchange of goods between nations, on a company’s performance (and subsequently the industry as well) has been the subject of many studies. While the literature on trade liberalization has shown there is a relationship between aggregate productivity growth, with respect to turnover and production decisions in certain types of firms, there has been limited study of the greater impact of large real exchange-rate movements.
However, the development of newer modeling considers how the exchange-rate variable can be applied to the study of the impact of domestic currency (the Canadian dollar) on company performance. In doing so, labor then represents production, which results in an appreciation in domestic currency. Foreign firms stand to benefit in this scenario as they receive a cost advantage with respect to domestic currency units. Domestic firms then face tremendous obstacles regarding competition from other domestic firms, in both domestic and export markets, the results of which directly impact pricing, or how much a firm can charge.
Considerable ripple effects ensue, including a reduction in a firm’s profit, and for some companies, just cause to abandon the industry altogether. Thus, when domestic currency appreciates it can negatively impact domestic firms in Canada. However, the financial model fails to address any impact of heterogeneity in productivity, which can then be explored by an investigation into the recent models of international trade and heterogeneous firms. As such, increased competition as a result of trade liberalization, in particular, can contribute to changes in a company’s market share—low-productivity firms are forced out while high-productivity firms absorb more market share.
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