The Canadian monetary system has evolved over several decades through the efforts of the country’s Legislative Council and Legislative Assembly. The Canadian dollar perfectly aligns with the US dollar since the introduction of the decimal system since 1859, which led to the valuation of the currency in the 1960s. However, the Canadian currency has been fluctuating due to changing fiscal, monetary policies and trade policies. For instance, her global trading partners have been amending both contractionary and expansionary policies in addition to the introduction of new trade barriers that have tremendous effects on the C$. A typical case is the Trump’s introduction of increased tariffs on imported goods that have threatened Canadian investors with holdings in the US. Nonetheless, Canada has an organized monetary system with various financial institutions like the commercial banks, nonbank financial institutions and investment banks among other. However, Canadian currency exchange rates have been fluctuating with changing values of the US dollar and interaction between specific economic determinants and trade legislations.
Evolution of Canada’s monetary system
The Canadian dollar (C$) is a currency that has evolved since 1841 under the administration of the Canadian government. The Canadian dollar was equivalent to the US $4 while C$ 4.40 was equal to £1. Through the 1851 Legislative Council and Legislative Assembly, Canada introduced the pound sterling system that could conform to the US dollar coinage that involved the decimal monetary system. However, this was changed two years later with the adoption of the gold standard monetary system whereby C$1=$US 4.86 2/3 though the 1853 Act did not recommend the use of coinage (Carney, 2009). However, the alignment of the Canadian dollar and the US currency took place in 1858 after the introduction of the new decimal system albeit the British gold standard was still the legal tender up to the 1990s. The country’s first denominations involving the decimal systems were introduced in 1859 through postage stamps.
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In 1861, countries like New Brunswick and Nova Scotia unified to use the US dollar unit following the Canadian decimal system. However, the two countries used the decimal system that relied on the Spanish dollars contrary to Canada that still complied with the British one. The three countries later united in 1867 to form the Dominion of Canada federation, a time when they now used one unified currency. Therefore, in 1871, a number of currencies from diverse provinces unified to use one Canadian dollar. The gold standard was later abandoned in 1933 with regards to the repercussions of the First World War. The exchange rate remained fairly constant at 1.1 C$= 1USD until the onset of the Second World War (Devereux, 2008). The stability of the Canadian dollar was probably due to the devaluation of the sterling that obliged Canada to resume the aforementioned stable exchange rate at C$1.1=US $1. This enhanced the float of the Canadian dollar, a fact that enabled the country's currency to regain its original rating by 1962 when C$1 was equivalent to the US $0.925. Henceforth, the value of the Canadian currency continued to rise (Carney, 2009).
However, there was a significant devaluation of the Canadian dollar years after 1992 up to and including 2002. This was marked by a US $61 cents that ultimately led to the decline of the C$; thus, leading to speculations regarding how the adoption of the US currency will lead to an economic boom (Devereux, 2008). However, the devaluation might sometimes be linked to a fall in US dollar that caused undervaluation of the Canadian dollar. Despite the ups and downs, the Canadian dollar underwent a dramatic appreciation between 2000 and 2007 with a general value increment of 79%.
Impacts of fiscal monetary and trade policies on the Canadian dollar
The government can reduce taxes imposed on Canadian citizens with a target of increasing individual incomes. Income increments imply that people’s demands for goods and services will increase because they will have enough to spend; thus, the country will import more. Therefore, the US will sell more dollars by buying foreign currencies to cater for the imports. Resultantly, the dollar exchange rate will drop dramatically due to the income changes, and the citizens will anticipate future inflation (Sims, 2016).
Additionally, the government can introduce expansionary policies intended to grow the economy through price changes. A reduction in government taxes with increased expenditures, the general demand for goods and services will increase, and this will lead to an increase in prices. As a result, Canadian exports become more expensive coupled with more attractive imports from the US. As a result, the Canadians will demand more of the US dollars to acquire US goods though the demand for the Canadian dollar will drop; thus, the exchange rate will reduce significantly (Sims, 2016). However, increased taxation and reduced government expenditures that comply with the terms of the contractionary policies would result in increased exchange rates though the bond prices will reduce tremendously. When the Canadian government sells its bonds, the interest rates will increase to the extent that most of the Canadian dollars will flow into the US since the foreign investors are too much interested in the higher interest rates.
For example, president Trump’s recent tariff saga greatly affected the Canadian interest rates. This made the Bank of Canada raise its interest rates by 0.25%. Currently, a Canadian dollar coin hovers around 77 cents in the US, which is a 5% reduction as compared to January 2018. Economists have anticipated a further reduction in the C$ devaluation as regards the continued saber-rattling. This is advantageous to the Canadian investors who own US investments.
Components of the Canadian monetary system (organizations and financial institutions)
Canada has a very organized banking system with better policies that regulate capital rations in transactions involving the United States. The system consists of federal agencies that control the operations of the financial sector including loan and trust companies and those that offer insurance services. For instance, the country has a cooperative credit movement that controls all cooperative unions and caisses populaires based in Quebec; though they are regulated by the provincial administration jurisdiction. The Office of the Superintendent of Financial Institutions Canada (OSFI) takes the leading role of regulating and overseeing operations of deposit-taking institutions including the insurance firms and private pension plans (McKeown, 2017). Hence, the OSFI further regulates all other financial bodies operating in Canada.
The country's banking system classifies financial institutions into five major categories like trust and loan companies, cooperative credit movements, life insurance, and security firms (McKeown, 2017). There are around 29 domestic banks and 24 foreign banks though the full-service foreign branches are 27. Inclusively, the banking system controls approximately C$4.6 trillion valued in terms of assets. Hence, this explains the extensive network of the system’s operations as regards the numerous branches and around 18, 711 Automated Banking Machines (ABM) (McKeown, 2017). Hence, it has the highest ABM per capita globally, which are operated through the use of debit cards, internet and telephone banking services. Currently, 26% of the Canadian banking transactions take place through the aforesaid ABMs.
Let us now delve into looking at the commercial banks as one of the financial institutions in the Canadian banking system and its specific roles in the economy. By 1987, such banks had no authority to transact businesses in capital markets in accordance with the purview of the investment banks. This regulation thwarted the growth of the investment banks in comparison to the progress of the American counterparts due to favorable political situations at state levels rather than the federal level (McKeown, 2017). Generally, the commercial banks accept deposits for safekeeping for the customers’ convenience. They operate their transactions through the use of debit and credit cards and even offer loans to businesses and people who would like to expand their business dealings. The commercial banks boost the Canadian economy by lending finances at fairly higher interest rates that surpass operating costs and the amounts they have to pay for the deposited funds (McKeown, 2017). Additionally, the banks offer wire transfer of finance among various countries to facilitate payment for goods and services.
Again, investment banks are financial institutions that formed from the commercial banks following the 1929's stock market crash and the subsequent Great Depression. In Canada, however, the banks act as intermediaries that offer some financial services on behalf of businesses and public institutions. For instance, they underwrite debts and equities, make markets and enhance mergers involving corporate reorganizations (McKeown, 2017). Such tasks sometimes include brokering for various institutional customers. This implies that the banks offer advisory services to the aforesaid clients. However, they concentrate on Initial Public Offerings (IPOs) including public and private share offerings (McKeown, 2017). The Canadian banking division rarely regulates the investment banks as compared to the levels at which commercial banks are supervised.
Insurance companies take the leading role in pooling risks through the premium collection from insured individuals and protect the stakeholders and their properties against fire, accidents and certain lawsuits. Therefore, the companies help individuals manage risks and protect their wealth based on the terms of arising claims. However, brokerages usually facilitate securities transactions involving suppliers and customers since they act as intermediaries. In the case of Canadian brokerages, a transaction fee is usually levied on trade orders involving stock to enhance the successful execution of the trade (McKeown, 2017). Therefore, full services must provide customers with pieces of investment advice, portfolio management, and trade finally execution that customers must pay commissions for in return. However, there are discounted brokerages that give investors enough time to conduct investment research and reach amicable decisions before the execution of the investment trade.
Finally, nonbank financial institutions also provide financial services to individuals and businesses as banks. In Canada, such institutions encompass a greater percentage of insurance companies. Hence, its reorganization facilitated the passage of legislation that protects insurance from becoming solid in various bank branches (McKeown, 2017).
Currency exchange rates and significant economic impacts on the exchange rates
The Canadian dollar is very influential in the exchange market due to its linkage to commodity prices and currency value. Currently, there is a close relationship between the C$ and the USD in relation to the exchange rate and commodity prices. A plethora of research has depicted depreciation in the aforementioned relationship based on the application of energy and non-energy commodity prices (Tkachuk & Hervieux-Payette, 2016). However, the commodity price fluctuations are not the single drivers of the CAD-USD exchange rate depreciation due to available multinational adjustments. Hence, the country is experiencing a floating exchange rate, which is associated with a number of advantages and disadvantages though the citizens experience inflation intended to maintain the domestic currency value.
Therefore, the value of the Canadian dollar is reflected in the USD prices relative to the commodity prices. For example, a reduction in international commodity prices like that of oil is responsible for the recent fall in the exchange rate of the Canadian dollar. Researchers have found that a $10 reduction in energy prices especially oil directly causes a decline of about 3¢ to 5¢ of the Canadian dollar (Tkachuk & Hervieux-Payette, 2016). This has been reflected in the decline in the commodity price indices by approximately 50% over the last 4 years. Hence, the key result of the decline is associated with the reduction in the prices of energy commodities. However, the major contributing factor to the significant reduction in commodity prices is the rates at which the Canadian economic growth declines in most emerging markets. This implies that the country has been lacking a proportional number of consumers of her commodities.
The variation in economic growth between Canada and the US has resulted in diverse economic policies that eventually cause a negative fluctuation in the Canadian dollar’s exchange rate. The continued fluctuations in Canada’s short-term exchange rates as compared to that of the US cause a decline in her dollar's exchange rate by 2%. From the current evidence, the US economic growth far surpasses that of Canada, and this causes an increased demand for USD though the demand for Canadian dollar declines. This situation ultimately leads to a general trend of a declining Canada-US dollar exchange rate. Therefore national decisions intended to boost economic growth directly influence Canadian monetary policies. In case of diverging monetary legislation between the US and Canada, the latter's bonds would have higher interest rates exceeding that of the US bonds by 0.6% points (Tkachuk & Hervieux-Payette, 2016). Therefore, the US dollar has greater economic impacts on the Canadian dollar’s exchange rates; in relation to imports, exports and both local and foreign dealings that in turn affect consumer spending habits in Canada.
Let us now analyze issues surrounding Canada’s economic exposure, transaction exposure and translation exposure with reference to the chart comparing monthly average exchange rates against the Canadian dollar per 1 US dollar in 2017/2018 (Antweiler, 2018). Canada measures her net present value (NPV) of domestic companies in relation to changes in cash flow due to fluctuating exchange rates. Therefore, the economic exposure in this context led to the sudden volatility of the Canadian dollar's exchange rate between August and September 2017. In addition to her trading links with the US and other major world economies through globalization, the country’s companies and consumers were greatly affected by the decline. The key issue here involved reduced cash flows that eventually tampered with companies’ operations final profitability. Resultantly, the country valuated her currency between September and November to counteract such negative impacts. Unfortunately, the valuation was met with higher costs of production and reduced profits from foreign currencies due to a stronger value of $1.
Again, Canada experienced a transaction exposure when her cross-currency dealings between the US and Mexico compelled her to devalue the C$ between December 2017 and January 2018 (Antweiler, 2018). This was probably a strategy to counteract the US threats to leave NAFTA, an idea that hurt the Canadian currency as depicted in the chart. Therefore, devaluing the Canadian dollar was an intention to prevent companies holding the C$ will not keep their money abroad even if the US pulls out of both NAFTA and WTO. Hence, Canada will curtail further devastating repercussions on stocks and as a result, would manage to fix values of cross-currency contracts prior to their settlements.
Finally, the translation exposure has diverse impacts on the Canadian financial performance as reflected on the chart hyperlinked above (Antweiler, 2018). The fluctuations in Canadian currency exchange rates affected her domestic prices. For instance, consumption goods imported from other countries imported intermediate goods and prices of locally produced goods valued in terms of foreign currency. There is a direct impact of fluctuating exchange rates on costs of domestic production, and the effect is increased prices of domestic goods. With reference to the chart, the translation exposure caused an overvaluation of assets and liabilities, which are specifically based in the US. If this is translated into Canadian currency, the fluctuations generated substantial gains between February and March 2018 as regards the cheaper access to USD.
Finally, investors should not buy the volatile Canadian currency since as the stocks fall, they will continue falling in value even in the future. This reality can be reflected in the past experiences of the average peak-to-trough drawdowns associated with stocks over the last half of the century. Again, trading counterparts would become richer through favorable US portfolio performances while the one investing in Canadian portfolios would stagnate. Hence, investing in the Canadian currency by buying their futures is a proposal that is likely to lead to enormous losses in the future as regards the adverse consequences of her economic devaluation.
References
Antweiler, W. (2018). PACIFIC Exchange Rate Service. University of British Columbia Press. Vancouver. Retrieved from http://fx.sauder.ubc.ca/cgi/fxplot?b=USD&c=CAD&rd=365&fd=1&fm=1&fy=2017&ld=31&lm=12&ly=2017&y=monthly&q=volume&f=svg&a=lin&m=0&x =
Carney, M. (2009). Foreign Policy Association: The Evolution of the International Monetary System. Retrieved from https://www.fpa.org/ckfinder/userfiles/files/2009_11_19_Carney_Future%20of%20International%20Monetary%20System.pdf
Devereux, M. B. (2008). Much Appreciated: The Rise of the Canadian Dollar, 2002-2008. University of British Columbia Press. Retrieved from http://www.sfu.ca/~kkasa/devereux_09.pdf
McKeown, R. (2017). An Overview of the Canadian Banking System: 1996 to 2015. Queen’s Economics Department Working Paper No. 1379 . Queen’s University Press. [Updated: April 17, 2017]. Retrieved from http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1379.pdf
Sims, C. A. (2016). Fiscal Policy, Monetary Policy and Central Bank Independence. Retrieved from https://www.kansascityfed.org/~/media/files/publicat/sympos/2016/econsymposium-sims-paper.pdf
Tkachuk, D. & Hervieux-Payette, C. (2016). The Fluctuating Canadian Dollar: What It Means For Canadians. Report of the Standing Senate Committee on Banking, Trade and Commerce . Retrieved from https://sencanada.ca/content/sen/committee/421/BANC/reports/USETHISVERSION2016-03-24_BANC_FINAL_CADReport_E.pdf
