Gold and The Canadian Dollar

December 4, 2000

The Canadian dollar saw a strong rise during 1999. See the Finance Dept website. (http://www.fin.gc.ca/activty/fininst/ar/efa1999_1e.html #Enhanced) When we check the correlation between our gold sales and the Canadian dollar though, we find that the fall of the Canadian dollar in 2000 does not directly reflect the loss of Canada's gold reserve. The sale of Canada's gold may be a factor here. And it may be possible to determine how much a factor. First though we need to factor out the other variables.

What else could be at work here? The 'usual suspects' are things like interest rate policy, (but Canada's interest rates have been higher than those in the US) or our economy, (but Canada's economy usually parallels that of the US with about a six month delay), political concerns (but Canada has reverted to its usual attitude of bored complacency with politics.)

When we look at the Finance Department reports we can see some interesting patterns. For example, Canada's total federal government debt began to rise dramatically in 1970-1971, when the US went off the gold standard. Canada's government debt rose dramatically for nearly thirty years afterwards. (ref. http://www.fin.gc.ca/afr/2000/frt001e.html #Table 1)

From the Finance Department 1999 report on the Exchange Fund Account we read that: "The Canadian dollar appreciated from about US$0.6552 in January to US$0.6894 in early May, supported by firming domestic demand, an improving current account balance and more stable world commodity prices." (http://www.fin.gc.ca/activty/fininst/ar/efa1999_1e.html #Enhanced)

From the same report, regarding Second Half of the year economic results: "The Canadian economy also expanded further, supported by the strong U.S. economy, improving domestic demand and recovering Asian economies and world commodity markets. In mid-November, the Bank of Canada raised the Bank Rate by 25 basis points to 5.00 per cent. For most of the period from May to November, the Canadian dollar fluctuated in a range of US$0.6662 to US$0.6894."

Here we see that the Finance department regards the Canadian economy as intimately tied with the US economy and the world economy in general. Thus a greater demand for commodities bodes well for the Canadian dollar, as it would be in greater demand, and thus would be expected to rise. Demand from the 'recovering Asian economies' in particular supported demand for commodities in 1999.

Conversely, the fall in the Canadian dollar in 2000 could be tied to the fall in demand for commodities worldwide and the decline in demand from the 'recovering' Asian economies in particular. (This can be the subject of a future report.)

Let us now look at what the Asian stock markets are telling us about what could happen in 2001. According to Peter Hartcher in the Australian Financial Review, they accurately forecast the collapse in 1997: (http://www.afr.com.au/premium/asia/2000/11/29/FFXNT9KF2GC.html) "If you had tried to predict the Asian crisis of 1997-98, you would have found no clues in the place where most economists looked - the economic growth statistics. They showed nothing but strength. But you would have found a clear warning if you'd checked the sharemarket. Thailand's stock prices were down by 70 per cent before the crisis hit."

Since the beginning of 2000 the stock markets of Thailand, South Korea, Taiwan, Indonesia, Japan are down from over 25% to over 40%. Informed investors in these economies are withdrawing cash. Share values are plummeting. Foreign capital is departing according to Hartcher. Delayed restructuring, bad debts and a weakened banking industry are likely to stall current attempts at recovery. According to Peter Hartcher: "The Nasdaq was foreshadowing a slowdown in US demand for IT goods. Why does this matter?

"First, because Asia depends heavily on the IT sector - more heavily than any other region of the emerging world. The IMF calculated that telecommunication, media and technology stocks account for a preponderant 54 per cent of the total capitalisation of Asian stockmarkets.

"There are some enormous concentrations of output. Taiwan makes half the world's notebook computers. Every time the price of a 64K Dram computer chip slips by $US1, South Korea loses half a billion US dollars' worth of annual exports.

"It matters also because the US buys more than half the region's output of these goods. And David Hale of Zurich Group points out that the 12-month growth rate of new orders for electronic components in the US has indeed fallen precipitously this year - from 38 per cent in May to 9 per cent in August.

"So when the Nasdaq began its 40 per cent dive, foreign investors did the only thing investors could be expected to do - sell East Asian stocks. And as capital fled and stock prices fell, so did regional currencies."

It looks like the winter of our discontent has arrived. As numerous analysts have suggested, the decline in demand from the US has the potential to develop into a major force that will challenge those responsible for providing liquidity in world markets.

If we accept the Finance Department view that the Canadian dollar receives support from the recovering Asian economies and the US economy, then we can see that the Canadian dollar is facing decline from these two large trading partners. Their stock markets are leading indicators which suggest that demand for Canada's products and thus for the Canadian dollar could decline further.

Gold has a place as a foreign reserve holding. Its sale by Canada's Treasury Department has perhaps been a factor in the slide of the Canadian dollar. More important for Canadians is the dependency of the Canadian economy on the current bubble economy in the US.

India and the U.S. trump Italy as top gold jewelry exporters.