| Loonie Tunes |
Dateline: 7/27/98
In January you may have read my first annual predictions for the upcoming year in my incarnation as Carnuck the Magnificent. It was a jocular tongue in cheek effort, more humour than serious predicting - a parody of Johnny Carson's Carnack persona.
Nevertheless, one of Carnuck's answers for Ed McMahon was "The Spice Girls and the Canadian Dollar." The question in the envelope was "What will have even less substance in 1998 than they had last year?" With the departure of Ginger Spice, the Spice Girls have 20% less substance now than they did before! As for the loonie - well! It closed on December 31, 1997 at 69.9 cents U.S.. On July 24 it closed at 66.71 cents after declining eleven out of the last twelve days. That's a decline of 4.56% - not as much as the Spice Girls, but a pretty hefty fall for the buck all the same.
Is this good or bad for Canada? Is it good or bad for you? What, if anything, should the government do? What can you do to protect your retirement savings? Read on!
I'm probably dating myself, but - remember the Diefenbuck? (Actually I was only a kid in high school during those years, but I remember!) Prime Minister John Diefenbaker devalued the Canadian dollar to 92.5 cents U.S. during his tenure in the early sixties. I don't remember too much of the politics of the day, being more interested in the Beatles, but I do remember that the government faced great scorn and ridicule from the opposition Liberals. Reams of ersats dollars were printed with a caricature of the Chief in place of the Queen and the inscription 92.5¢ in place of one dollar. (I wish I still had one. it would probably be a valuable collectors item now!)
In any event, the dollar shrank and Dief got booted for Lester Pearson who paved the way for Pierre Trudeau and twenty years of profligate spending. Did the country collapse from the cheap dollar? No it did not. The sixties were boom years. The cheap dollar helped boost exports, provided stability and life went on as before.
If anything can be said to have killed the Canadian economy, it was the spendthrift ways of the Trudeau Liberals which brought on an ever increasing federal debt load. This deficit spending was highly inflationary and the Liberals were compelled finally to stop inflation in the early eighties with high interest rates. It was a painful but necessary treatment to stem a looming runaway inflation and bring stability to the economy.
The current situation is much different. Inflation is low. The economy is growing. The Bank of Canada is sticking to a low interest rate plan for several reasons. One is the effect of interest rates on the economy.
Businesses borrow money to expand, to retool plants, to do research and development. All this borrowed money has to be paid back with a premium, the interest. Interest can be a significant factor in a company's costs and profitability. When rates go up, the interest expense for business goes up. Profits decline. With interest rates stable, businesses can effectively plan their growth and expansion.
So that's one reason the government is maintaining a low interest rate policy. The economy is growing, but fragile. An uptick in rates could have a severe negative effect on the economy. But there's a second reason, not much bandied about in the media. And that reason is purely political.
The government has succeeded, after several years of pruning budgets and raising taxes, to finally balance the budget. A major factor in their ability to do this has been declining interest rates. They're also now poised to start cutting taxes, something the people have been agitating for. To raise interest rates now would throw the balanced budget out the window. It would delay and maybe even scuttle for good the promised tax breaks.
With a Reform opposition calling for tax cuts, the economic fragile and the balanced budget just barely so, it would be political suicide for the government to throw it all away with an interest rate hike. Unless inflation starts manifesting itself in ways other than the booming stock market, the government has no reason to raise rates.
So is the falling loonie good or bad? The question properly should be, is an interest rate hike good or bad? And that, as discussed above, is bad news.
The value of the loonie itself is a relative question. While the loon has declined against a very powerful U.S. dollar, it has held its own or gained against most other currencies, particularly Asian currencies.
Certainly the U.S. is still Canada's largest trading partner. For products imported from the U.S. we will pay a higher price. On the other side of the coin, the price of our goods to Americans is lower. For exporters this is good news. Lower prices generally mean higher demand. Exports will increase. Tourism is reaping many benefits from the low loonie as Americans flock to take advantage of cheap Canadian vacations. So there is a trade-off.
Then there are commodities produced in Canada that are universally priced in American dollars, such as oil, natural gas or gold. Producers of these commodities will see their profits rise as their revenues increase due to the exchange.
With countries whose currency is faring even worse against the Yankee dollar than the loon, the reverse will apply. Our exports will be more expensive for the trading partner. Their goods will become cheaper.
The upshot is that the falling loonie may produce a dramatic change in our trading arrangements. We'll start importing more Asian goods and fewer American goods. The price of Hondas will come down. Unfortunately, the price of American produced food may go up. Count on more expensive orange juice. Overall, these changes will balance out over time.
In any event, you or I are not likely to have much influence on government policy anyway. But what about your portfolio? How can you turn the falling loonie to your advantage in investment?
There are plenty of good American stocks out there. Every portfolio should have some! If you own an American stock that does nothing while the loonie declines 5%, you've made 5% on your investment. If you invest well and your stock rises, the value of your holdings are compounded by any decline in the value of the Canadian dollar.
If you want to play it safe, fixed return investments denominated in Amercian dollars will produce a bonus equal to any decline in the loon. American Treasury Bills already pay a higher return than Canadian ones. If the Canuck buck continues to decline, you make even more.
Canadian mutual funds investing in U.S. equities will gain on any decline of the Canadian dollar.
But what about your RRSP? The rules only allow you to invest 20% of your portfolio in foreign investments. Make sure you max out in that area. And you probably want to put a lot of that into U.S. investments, whether they be equities, bonds or money market instruments.
If you'll remember from a previous article here, there are a fair number of investment funds that are 100% foreign invested but are considered 100% Canadian content for your RRSP because they use derivatives. Examples are Canada Trust's Amerigrowth, Eurogrowth and Asiagrowth Funds. Using such funds you could be 100% invested in American investments while meeting Canadian content requirements for your RRSP. The most recent listings in the Southam newspapers showed 26 such American Equity Funds, 35 International Equity Funds, 36 International and American Bond Funds and 9 International and American Money Market Funds.
If you have extra cash sitting around, open a U.S. dollar savings account and deposit any savings there. If you come across an American dime or quarter in your change, save it for your next trip south. It used to be a waste of most people's time to bother saving such small change, but now that it means making 50% on that coin, it's worth it!
All of these strategies will help you get the biggest bang for your buck. Do it!
Bank
of Canada's Monetary Policy
Exchange
rates, interest rates, money supply and stock prices - from
Statistics Canada
Canadian
Economic Indicators - from Statistics Canada
Canadian
Dollar Futures Prices - from the Chicago Mercantile Exchange
My List of Bonds, Interest rates
& Money links
Disclaimer: As with all my columns here, I should re-iterate a precaution. I am not a professional financial advisor. I am a financial journalist and editorialist. The views in these columns are my personal opinions.
American Readers: Looking for a broker who can sell you Canadian stocks? One of my brokers is licensed to sell securities to Americans in 26 states. She works for Canaccord Capital which is an excellent company with a superb research department. They are particularly knowledgeable on resource issues. Send me a note if you want to get in touch with her.
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