November 9th, 2004

Blurb: In recent months the Canadian dollar has been hitting heights not seen in decades. That's great news if you're planning to go to Disney World or to buy U.S. goods. But a strong loonie has its drawbacks.

The perils of a high dollar

By Peter Diekmeyer o Bankrate.com

When the American economy was on fire during the tech bubble some analysts were predicting that the Canadian dollar, --then flirting with the U.S. $0.60 level,-- would soon be a thing of the past, and that we would eventually have to ditch it in favor of the greenback.

What a difference a few short years make. These days, sparked by a boom in commodity prices, it's the Canadian currency that's on fire. The loonie, --which this week traded in the U.S. $0.83 range,-- has risen by close to 30 percent against the U.S. dollar during the past 22 months.

The loonie's strength is a bonanza for Canadians. It means that our collective national wealth has increased enormously without us having to do much of anything. But just because a strong dollar is good for Canada as a whole, it doesn't means that it is good for all Canadians all the time.

The return of cross border shopping

In a nutshell, a rising Canadian dollar helps anyone who buys products from the U.S. and it hurts those who are trying to sell to the U.S. Its most visible manifestation is the return of that age-old Canadian tradition of taking a quick trip across the border to pick up a few bargains. And that doesn't just apply to consumers. Canadian companies that import raw materials, machinery, equipment and other products from the U.S. will also get a break.

Tourism is another sector that is likely to be affected. Snowbirds are going to find that their Christmas vacation costs will drop dramatically this year for U.S. destinations. The reverse is also true, and Americans coming to Canada for events such as the Stratford and Shaw festivals will see price increases.

Exporters could be hit

By far the biggest potential losers from the strong currency are Canadian exporters. A strong Canadian dollar makes it more expensive for U.S. companies to buy Canadian products. So far the problem seems manageable. The Canadian economy is rolling along just fine, creating 34,000 jobs in October. That said, some sectors are feeling the pain.

"It's getting very bad," Gerry Fedchun, head of the Automotive Parts Manufacturers' Association, told the National Post recently. "Some products are being sold at less than their cost to produce after the exchange rate is taken into account. They can't possibly make money at these rates."

Fedchun recently met with Bank of Canada officials to ask them to cap interest rates in order to slow the loonie's rise, but was unsuccessful.

During the past decade Canadian businesses have done well by exporting to the U.S., relying the cheap Canada currency to keep them competitive with U.S. firms. But many companies decided to bank their profits, rather than making the strong investments in productivity enhancements --such as new equipment, retraining employees and outsourcing,-- that would keep them competitive over the long term.

But now the chickens are coming home to roost. With the Canadian and the U.S. dollars approaching purchasing power parity, the cost advantage long held by Canadian firms has vanished and they will now have to compete on a level playing field.

The extent of the problem is massive. Canadian businesses are enormously dependent on U.S. sales to keep their machines running. During 2003 Canada exported $328 billion in goods and services to the U.S. Exports comprise well over 30 percent of Canadian GDP. And more than 85% of our merchandize exports are sent South of the Border.

But as bad as things are, they could get worse. Many think that the loonie's rise climb isn't over. The U.S. has a huge merchandise trade deficit, and a burgeoning budgetary deficit, both of which require huge imports of capital to keep financing.

CIBC World Markets recently predicted a U.S. $0.85 dollar by year-end or early 2005. If the Canadian currency continues to stay strong, exporters will have to take significant steps to stay competitive, and job cuts are likely.

Whether that happens and to what degree remains an open question. But one thing is certain, it'll be a long time before you hear anyone talk about adopting the U.S. dollar.

Peter Diekmeyer is the Montreal Gazette's management columnist. He can be reached at: peter@peterdiekmeyer.com

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