Can I Get Poutine with that US Dollar Depreciation?

Economics, Premium POM

By JC Collins

Whenever we go to a restaurant I usually order something unhealthy.  Burgers, chicken fingers, or deep fried beer-battered cod.  Most Canadian fine dining now offers the choice of poutine as a side dish.  For those who don’t know, poutine is a blessing bestowed upon us by the province of Quebec.  It is a batch of those crunchy “freedom fries” covered in cheese curds and mouth-watering gravy.

Of late I’ve noticed that some menu items are becoming more expensive.  This is due to the depreciation of the Canadian dollar against the US dollar.  Food stuff, like some chicken fingers or some beef paddies, which are imported into Canada*, are subjected to this cost increase.

But not poutine!

Those greasy fries and sodium injected cheese and gravy are all produced and sold right here in Canada.**

(*Not all chicken fingers and beef patties are imported. Big US chain restaurants, and some Canadian, will import, but not all.)

(**May not apply to all fries.)

Most meals start as fantastic culinary voyages into the well-known.  But before the end the fat and salt mix together and a great lethargy overcomes me.

Outside of using poutine as an introduction prop for this post, the above information is, for the most part, true.  Import costs for Canadians have increased over the last few months as the US dollar has appreciated.  Many Canadian are waiting for this to begin trending the other way.  But I think it will be a little while longer for the loonie.

There are multiple factors which can influence the valuation of a currency.  These factors are monetary policy, inflation, strong growth, demand for currency, trade balances, and falling export prices.

This last item – falling export prices, has worked alongside a strengthening US dollar to hammer the Canadian dollar.  The fact that the US held a crude exporting ban for the last 40 years means the collapse in crude prices has not affected the valuation of the USD.

With the crude exporting ban now lifted, and as the valuation of crude increases down the road (one can hope), the US dollar will benefit from the appreciation leverage.  This will help offset the depreciation leverage which will come from increasing interest rates and a decreasing international demand for dollars as demand for Chinese renminbi increases.  See post Renminbi Demand is About to Explode.

The balance required to increase interest rates while depreciating the dollar, for the purpose of increasing exports and lowering the debt-to-GDP ratio, may appear daunting and impossible, but it is happening and will become more apparent in the coming months.

When the US dollar depreciation does begin, it will be worth revisiting some of the previous posts here on POM.

In the post Fed Rate Hike in a Changing World I stated the following:

“…higher interest rates will reduce the willingness to borrow and will eventually lead to a reduction in economic activity, such as mortgages, car loans, credit card use, and overall money velocity should temporarily dampen. This reduction will cause a reduction in capital inflows.”

“After the initial response, the above factors will extrapolate the lower demand for the currency which will cause a depreciation in exchange rate.  A depreciation which the US desperately needs to increase exports and spur domestic production to reduce the debt-to-GDP ratio before the next fiscal budget.”

“The natural inclination to consider that the USD will continue to appreciate within an economic environment of increasing interest rates is not as supported as we would have thought.  When we add the increasing demand for dollar alternatives, such as the Chinese renminbi, we see that foreign capital will have additional places to move and settle.”

This information covers the inflation component of factors that can influence currency valuation.  The inverse valuation which the USD holds against other currencies will not be applicable as its reserve status is slowly diluted by the renminbi and the euro.  (Yes, the euro!)

For those who expect that the US dollar will collapse and be “relegated to the dustbin of history” (you know who you are), I offer the following excerpt from the post The Correlation between Fed Rate Increases and Renminbi Internationalization in 2016, which discusses the slow dance between the US and China in regards to the transformation of the international monetary framework:

“The depreciation of the USD which many expect to cause severe volatility will in fact lead to greater job growth and a decrease in the debt-to-GDP ratio.  There will be some volatility, such as stock market adjustments and some bond market instability, but the transition itself will unfold with the main structure of the American economy intact and growing at a brisk pace.”

Once the USD depreciation against the currencies of its largest trading partners begins, the Canadian dollar will linger behind for a while.  The shifting variables surrounding the price of oil makes it hard to determine the time frame fully, but some fundamentals can be defined. Once oil does turn and begins its upward climb again, the Canadian dollar will begin to appreciate against the USD.

The US dollar, for its own part, will be balancing the depreciation and appreciation principles in an effort to maximize its position in the multilateral monetary framework while increasing domestic production and exports.  What this means for dollar valuation and exchange rate arrangements can be interpreted as both positive and negative.  It all depends of the socioeconomic perspective one chooses to view it from.  – JC