Why is the value of the Canadian Dollar Rising?

Steve Poloz, Chief Economist of Export Development Canada, received his PhD from The University of Western Ontario. It follows that he is a very bright guy.

Steve puts out a Weekly Commentary, which is available on-line and by e-mail subscription, in which he looks at current events and developments and gives his assessment of various economic situations.

In his November 10, 2004 issue, Steve takes on the question of why the U.S. price of the Loonie (aka the Canuck Buck [aka The Canadian Dollar]) has been rising. Like most economists, he points out that internationally the Canadian economy is heavily weighted toward providing commodities, for which prices have been rising rapidly, thus increasing the demand for Canadian dollars. He also points out the Purchasing Power Parity arguments don't really explain the recent exchange rate movements because those theories have been indicating that the U.S. price of a Loonie should have been up around or over $.80 U.S. for many years now, not down around 62 cents, as it was two years ago.

For the most part, I think he's right. There is one other consideration, though, which follows from a conversation I had with valued colleague, Robin Carter, last year. Exchange rates have to do with risk as well as relative prices. And in the past year, investments in the U.S. have become financially riskier due to the large deficits there and fears of future inflation. At the same time, threats of Quebec separation in Canada seem to have diminished considerably, reducing the risk of inflation and economic disruptions in Canada. The confluence of rising financial risk in the U.S. and falling financial risk in Canada has likely also contributed to the rise in the U.S. price of the Loonie.