A Brief History of the Loonie
Canadian snowbirds making their annual migration south are faced with significantly higher costs based on a dramatically weaker dollar. Since the high of $1.10 US in November 2014, the loonie has fallen 32% against the US greenback. A recovering US economy and the rapid collapse of commodity prices have driven the dollar close to the 70 cent level. For individuals and businesses working in US dollars, it is important to recognize that these swings in the value of the Canadian dollar are normal, and that the US exchange rate can stay lower for longer than many anticipate. As a result, Canadian investors need to diversify their portfolios internationally to help smooth out these fluctuations and maintain their purchasing power.
“Modern” exchange rates for the Canadian dollar trace back to 1970, when the international system of fixed exchange rates under the Bretton Woods agreement collapsed, and the Canadian government allowed the value of the loonie to float freely on world markets. Successive governments and the Bank of Canada have spent the following decades dealing with a variety of economic influences in an attempt to defend the “fair value” of our currency. From the outset of the floating rate regime, the value of the loonie has been inextricably linked to commodity prices. The 1970s saw a tripling of oil prices with the first OPEC oil shock, and a generally strong demand for raw materials, which pushed the loonie through parity and to a high of $1.04US in 1974. As the US economy fell into an oil induced recession, concerns arose in Canada over the impact of a high dollar on manufacturing and employment, which turned into stagflation. Imposing wage and price controls and pushing the bank rate to 14% ultimately lowered the loonie to the US$0.86 level by the end of the decade.
During the 1980s, the Canadian dollar traded in a broad range, falling in the first half of the decade on the uncertainty of a Quebec referendum, and the Bank of Canada raising rates to a record 21.25% to curb inflation. The dollar then reached a record low of US$0.69, gradually recovering from that point due to improving commodity prices, expansionary government spending and the adoption of the US Free Trade agreement to close the decade back at US$0.86. The 1990’s were not kind to the loonie as accumulated government deficits spooked international investors,and once again, commodity prices fell during the Asian financial crisis of the late 90s, driving the dollar to a low of US$0.63 in 1998.It’s somewhat surprising to recall that the loonie began the 21st century by falling to its all-time low of US$0.618 in January, 2002 affected by the same volatility that has plagued financial markets so far this century. International terrorism, US fiscal imbalances and the rapid rise of emerging markets, namely China, have taken the loonie on a breathtaking ride from US$0.62 to a high of $1.10 in November 2007 and back down to the current level of US$0.72 over the last 15 years.
For Canadian based investors, the history lessons are clear. Despite increased globalization, the value of the loonie remains firmly tied to the US economy and the associated variables of interest rates and inflation. Over the past 25 years, the Canadian dollar has averaged US$0.81, so given a lower cost of living in the US, resident Canadians may choose to live with that rate. However,the loonie remains a commodity based currency which has swung at least 20% against the US dollar in each of the last four decades, and the declines can last up to 10 years. Investing in US dollar denominated assets as the Canadian dollar peaks can provide growth and income during the inevitable downturn, while exposure to Euro based investments may provide consistent income flows based on a stable, long term exchange rate with the Canadian dollar. For investors who did not manage to take advantage of the last cycle, we urge them to discuss preparations for the time when the great Canadian Loonie takes flight once again!