From Mike Moffatt,
Your Guide to Economics.
FREE Newsletter. Sign Up Now!

Nov 11 2007

Note: The article below was published on October 27, 2004. To see a November 2007 treatment of this topic, see: Analyzing the Value of the Canadian Dollar - Introducing MERT.

[Q:] I've noticed that the Canadian Dollar has increased in value quite a bit relative to the U.S. Dollar over the last few months. I was wondering if this was because the Canadian Dollar is doing well, or because the U.S. Dollar is doing poorly?

[A:] Great question!

Recall that in the Beginner’s Guide To Exchange Rate we saw that an exchange rate is a relative price: it’s the amount you have to pay in one currency to get a specified amount of another currency. So to rephrase your question, has the price or value of the Canadian dollar gone up, or has the price or value of the U.S. Dollar gone down?

The easiest and also the most revealing way to examine this question is by throwing other currencies into the mix. If we see how the Canadian and American Dollars have done against other major currencies such as the Japanese Yen and Euro, we can see if the Canadian-American exchange rate has changed because the Canadian Dollar has become more valuable of the American Dollar has become less valuable.

The idea behind it is simple: If we see that the Canadian Dollar hasn’t moved much against the Euro, but the American Dollar has dropped significantly, we’ll know that the changes in the Canadian-American exchange rate are mostly caused by a devalued U.S. Dollar. Conversely, if we find the U.S. Dollar has held steady against the Euro while the Canadian Dollar has risen in value, we’ll know that changes in the Canadian-American exchange rate were largely caused by an appreciating Canadian Dollar.

We’ll compare both currencies against each other and five other major world currencies: the Euro, the British Pound, the Japanese Yen, the South Korean Won, and the Mexican Peso. We’ll consider how the exchange rate has changed between two dates: May 1, 2004 and October 27, 2004. First up, the U.S. Dollar.

U.S. Dollar vs. 6 Currencies

1. Against Canadian Dollar: Down 10.58%
2. Against Euro: Down 5.69%
3. Against British Pound: Down 2.74%
4. Against Japanese Yen: Down 3.66%
5. Against South Korean Won: Down 6.21%
6. Against Mexican Peso: Up 0.88%

From these statistics we see that the U.S. Dollar has fallen in value against 5 of the 6 other currencies and has only risen slightly against the Mexican Peso. However, the American Dollar has fallen the most against the Canadian Dollar. If you’ve aware of the link between exchange rates and arbitrage you’ll know that this should mean the Canadian Dollar will have risen against the other currencies. The statistics bear that out:

Canadian Dollar vs. 6 Currencies

1. Against U.S. Dollar: Up 11.88%
2. Against Euro: Up 5.52%
3. Against British Pound: Up 8.80%
4. Against Japanese Yen: Up 7.79%
5. Against South Korean Won: Up 7.75%
6. Against Mexican Peso: Up 12.86%

The Canadian Dollar is up over 5% in value over each of these major currencies; that’s a pretty rapid ascent in the last few months. Again, note that other than the Mexican Peso, the Canadian Dollar has gained more from the U.S. Dollar than it has from any other currency. From the statistics gathered in this article, it’s clear that the huge jump in the Canadian Dollar relative to the American Dollar over the last six months is due to both the Canadian Dollar appreciating on world foreign exchange markets and the U.S. Dollar falling in value.

If you wish to ask an economics related question or comment on this article you can do so by using the feedback form.