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How Dependent is the Canadian Dollar on the US Economy?

How Dependent is the Canadian Dollar on the US Economy?

The Canadian Dollar (CAD), popularly called the Loonie, is one of the seven major global currencies, in terms of transaction volume, and the fifth largest reserve currency in the world. Canada’s economic situation is closely related to its exposure to major commodities, including petroleum, minerals, food products and grains. Trade flows from the export of these commodities influence investor sentiment on the CAD.

When it comes to trade partners, Canada and the US have one of the strongest relationships globally, with each country accounting for over half of the other’s imports and exports. The nations share the world’s longest secure border, which goods and services worth over US$1.7 billion cross daily. Of the 10 major global economies, no country is as dependent on the US economy as Canada.

It, therefore, comes as no surprise that CAD traders closely follow the US economy. Although both countries have diverse economic policies, conditions in the US inevitably spill into the Canadian markets.

The North American Free Trade Agreement (NAFTA)

Canada and the US have one of the most successful bilateral trade relationships in the world, in which NAFTA is a critical component. Technically, it is an agreement between three countries, the US, Canada and Mexico. But the US and Canada form a distinctly major economic partnership. Only 12.6% of the US GDP comes from exports, making it a major consumption-based economy. The United States provides a market for 76.7% of Canada’s exports.

The two countries not only sell goods to each other, but also have manufacturing partnerships, where they create products for sale at home and in other countries. In doing so, they create millions of jobs on both sides of the border. Over 9 million US jobs depend on its trade with Canada, primarily in the supply-chain and manufacturing industries.

Oil: The Most Important Canadian Export to US

Oil is one of the most significant Canadian exports to US soil. Canada’s National Energy Board reports that over 99.1% of the country’s crude oil exports were to the US in 2017, and that 95% of Canada’s exports to the US consisted of petroleum oil. Almost 63.7% of Canada’s oil exports to the US, goes to the latter’s Midwest region. The Rocky Mountain region comes in a close second, accounting for a 20% consumer base for Canadian oil exports. Both these regions are not well connected to the Atlantic and Pacific Oceans and have established pipeline infrastructure in order to transport oil from Canada. Finding any alternate sources of oil for these regions would entail significant costs.

But the US is not wholly dependent on Canadian oil. If it decides to get its oil from elsewhere or increases its domestic oil supply, it would have a negative effect on the Canadian economy. In the market, there are numerous other oil sellers vying to gain the US as a customer. In this regard, Canada has more to lose and shows greater dependency on US demand-supply for oil.

This makes the CAD closely tied to global oil prices. When demand for its oil increases in the United States, its terms of trade improve, since its oil becomes relatively more valuable than that of other oil producers. As a result, the value of the CAD surges against the USD.

An example of this is the extreme depreciation in the CAD against the USD between January and June 2016. In January 2016, the CAD dropped below US$0.70, on account of low global energy demand and rising strength of the USD. One reason was also excessive oil supply, due to newer oil and gas extraction techniques, like fracking, in the US.

A Gradual Decrease in Dependency

Apart from oil, other commodities like dairy products, softwood lumber, lobsters and salmon, are traded between the two countries. Behind these supply chains are millions of US workers, who are dependent on the trade arrangements between the two countries. The state of North Dakota, for instance, sends 84% of its exports to Canada, consisting primarily of ethyl alcohol, oil and wheat. There are strong people-to-people ties in the border cities too. There are 291 Canadian-owned companies in the state of Ohio, accounting for 308,700 local jobs. Ohio exports goods and services worth US$20 billion to Canada every year.

A recent report released by the University of Calgary, stresses the fact that Canada enjoys a diversity of export products, more than countries like Australia, Mexico, Poland and Hong Kong. Contrary to popular assumptions, it is not wholly reliant on energy or automobile exports to USA. This gives it an advantage of increasing trade diversification.

In fact, the Canadian trade deficit declined considerably in the recent past, due to its alternative trade partnerships with other countries, following the steep tariffs levied by the US on Canadian goods. In January 2019, Canadian exports registered 2.9% growth, narrowing the trade deficit to C$4.2 billion, from C$4.8 billion the previous month.

A good thing is that Canada favours immigration, unlike USA and Europe. Its system strongly favours highly skilled immigrants, who can contribute to its economy. So, despite lower fertility rates, its population growth rate is now higher than that of the US. As President Trump’s negative stance on immigration cuts the flow of skilled labour in important US industries and tech-hubs, Canada’s multi-cultural highly skilled workforce will give major companies the incentive to open offices in Canada.

Risks to the Canadian Economy

NAFTA has been unable to prevent certain risks to the Canadian economy. The country had primarily focused on developing its oil sector, but global oil prices have been on a decline. The market is over-supplied, so even if prices have stabilised for now, the situation may reverse.

The US-Mexico relationship also poses competition for the US-Canada relationship. Canada has lost significant US market share to countries like Mexico and China, who can produce similar goods at lower prices. In this respect, it shares its woes with the USA, which also faces loss of jobs and hollowing out of its industrial capacities to these countries.

Conclusion

For the time being, the Canadian economy is still hugely dependent on US market forces, but the recent trade wars have proved that Canada can still sustain its economy without a major relationship with the US.

In April 2019, the Canadian labour market recorded its fastest growth since 2010. Also, unlike 2018, there has been a 28% increase in oil prices in the first half of 2019, which is good for the CAD.

 

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