Exchange Rates and Commodity Prices

We've seen that the Canadian-American exchange rate and commodity prices, particularly the price of food and industrial materials, have moved in tandem over the last two years. If Americans are buying more Canadian food and industrial materials, then our explanation for the data makes sense. Increased American demand for these Canadian products would simultaneously cause an increase in the price of those products, and an increase in the value of the Canadian Dollar, at the expense of the American one.

Unfortunately, we have very limited evidence about the amount of goods the American are importing, but what evidence we have looks promising. In "The Trade Deficit and Exchange Rates we looked at Canadian and American trade patterns. With data provided by the U.S. Census Bureau we see that the U.S. dollar value of imports from Canada has actually went down from 2001 to 2002. In 2001, Americans imported $216 billion of Canadian goods, in 2002 that figure dropped to $209 billion. In the 11 months of statistics available, the U.S. has already imported $206 billion in goods and services from Canada, so the value of 2003 imports will be higher than 2002 imports, once the figures for December are released.

One thing we have to remember, though, is that these are dollar values of imports. All this is telling us is that in terms of U.S. Dollars, Americans are spending slightly less on Canadian imports. Since both the value of the U.S. Dollar and the price of commodities has changed, we need to do some mathematics to find out if the Americans are importing more or less goods.

For the sake of this exercize, we will assume the United States imports nothing but commodities from Canada. This assumption does not make the results much different, but makes the math much easier so we'll keep it.

We'll consider 2 months, October 2002 and October 2003, to show how the amount of exports has increased significantly between these two years.

Imports From Canada - October 2002

For the month of October 2002, the United States imported $19.0 billion of goods from Canada. The commodity price index for that month was 107.2. So if a unit of Canadian commodities cost $107.20 that month, the U.S. bought 177,238,805 units of commodities from Canada during that month. (177,238,805 = $19B / $107.20)

Imports From Canada - October 2003

For the month of October 2003, the United States imported $20.4 billion of goods from Canada. The commodity price index for that month was 119.6. So if a unit of Canadian commodities cost $119.60 that month, the U.S. bought 170,568,561 units of commodities from Canada during that month. (170,568,561 = $20.4B / $119.60). From this calculation, we see that the United States bought 3.7% less goods over this period, despite a price hike of 11.57%. From our primer on price elasticity of demand, we see that the price elasticity of demand for these goods is 0.3, meaning they're very inelastic. From this we can conclude one of two things:

1. The demand for these goods are not at all sensitive to price changes, so American producers were willing to absorb the price hike.

2. The demand for these goods at every price level increased (relative to former demand levels), but this effect was more than offset by the large jump in prices, so overall quantity purchased declined slightly.

In my view, number 2 looks a lot more likely. The U.S. economy has been spurred by massive government deficit spending. Between the 3rd quarter of 2002 and the 3rd quarter of 2003 the U.S. Gross Domestic Product increased by 5.8%. This GDP growth indicates increased economic production, which would likely require increased use of raw materials such as timber. The evidence that increased demand for Canadian commodities has caused the rise in both commodity prices and the Canadian Dollar is strong, but not overwhelming. We will have to watch both the Canadian Dollar and commodity prices in 2004, to see if this trend continues.

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