Foreign Exchange and the Canadian Dollar

22 The Canadian dollar has experienced dramatic fluctuations in recent years, rising from a low value of 62 cents U.S. in 2002, to levels that now meet or exceed parity with the U.S. dollar. These fluctuations have had tremendous impacts on exports, investment, and employment in many Canadian industries and regions. More recently, currency issues have become highly controversial in global economic diplomacy, too. For example, conflicts over currencies (especially between the U.S. and China) dominated the recent G20 summit in South Korea. Those conflicts were not resolved, and hence uncertainty and conflict over exchange rates will continue to mark much international interchange. What determines exchange rates, and why do they matter? This primer introduces some of the key issues

and concepts, to help make sense of the volatility. If you live in one country, but want to make a purchase in another country, you need to obtain some of that nation’s currency in order to facilitate the purchase. Therefore you arrange through a bank or some other financial intermediary to purchase some of that foreign currency, using some of your home currency. That transaction – converting one national currency into another – is called foreign exchange, and the system that arranges for those transactions is the foreign exchange market or system. There are many purposes for which foreign exchange is required. The most concrete reasons are to pay for imports from another country, or to visit that country and pay for things while you travel there. Businesses might also need to convert currency in order to pay for an investment in another country. In less concrete motivations, financial investors could convert currency in order to purchase financial assets (like bonds or corporate shares) in another country. In some cases, financiers purchase another nation’s currency purely for the purpose of holding that currency – hoping that its value (relative to other currencies) will increase, thus generating a speculative profit. The price of one unit of a currency (say, a dollar) is the amount you must pay in another currency in order to buy it. If this “price” of a currency rises, it becomes more expensive relative to other currencies, and it is said to “appreciate.” If a currency’s price falls, then it “depreciates.” A strong currency allows its owner to purchase more from other countries (goods, services, assets), since the currency is more valuable internationally. Today, most countries allow their currencies to trade freely on commercial markets. For these currencies, foreign exchange rates fluctuate each day on the basis of supply and demand – Foreign Exchange and the Canadian Dollar: A Primer Jim Stanford What is foreign exchange? Why buy and sell foreign exchange? What is the price of foreign exchange? What determines foreign exchange rates (I)? 23 Under flexible exchange rates, rates reflect the supply and demand for a currency. But what are the deeper factors behind those supply and demand pressures? To a small degree, real economic factors like trade and foreign investment flows might influence exchange rates. A country with a trade surplus (exporting more than it imports), or experiencing a strong inflow of foreign investment, might...

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