Smith, Vincent H.

English

Research Papers in Economics

U.S. and Canadian Currency Values and Exchange Rates
Vincent H. Smith
 B R I E F I N G
        Briefing No. 49                November 2003
                             
                            
                            
Agricultural Marketing Policy Center
Linfield Hall
P.O. Box 172920
Montana State University
Bozeman, MT 59717-2920
Tel: (406) 994-3511
Fax: (406) 994-4838
email: ampc@montana.edu
website: www.ampc.montana.edu
Objective
Analysis
for Informed
Decision Making
The Agricultural Marketing Policy Center
would like to acknowledge the support
provided by the Montana State Department 
of Agriculture for this project.
Many countries have their own
currencies and manage their own
monetary systems.  In general, they
also trade with one another.  When a
business or person in one country buys
goods or services from a business or
person in another country, use of
different currencies is a complicating
factor.  For example, if a Japanese flour
mill wants to purchase Hard Red
Spring Wheat from the United States,
at some point the Japanese flour mill
has to obtain U.S. dollars to pay the
U.S. grain company for the wheat. It
does so by purchasing U.S. dollars with
Japanese yen in the foreign exchange
market. 
Often, one country’s currency has a
completely different name than another
country’s currency.  In these cases, it is
clear that the rate at which the
currencies are exchanged for one
another in international currency
markets is not on a one-to-one basis. 
For example,  Japanese currency is
called yen and United States currency
is known as the U.S. dollar.  Most
people don’t expect one yen to trade
for one dollar.  Sometimes, two or
more countries have their own currency
and manage their own monetary
systems but the currencies have similar
or even identical names. This gives
some people the impression that the
two currencies should trade on a one-
to-one basis.  Consider the United
States and Canada.  The Canadian
dollar and the U.S. dollar are just as
independent of one another as the
Japanese yen and the U.S dollar.  The
Bank of Canada manages the Canadian
monetary system and, the Canadian
dollar.  Likewise, the Governors of the
Federal Reserve Board manage the U.S.
monetary system and the U.S. dollar.
Moreover, this has been the case for a
long time.  Just as one yen buys a
different amount of goods and services
than one U.S. dollar, one Canadian
dollar buys a different amount of goods
and services than one U.S. dollar.  There
is no reason to expect that a yen or a
Canadian dollar should be equivalent to
a U.S. dollar.
Exchange Rates:
The value of a country’s currency can
be measured in several ways.  Two
commonly cited measures are bilateral
exchange rates and summary indexes.
Bilateral Exchange Rates
A bilateral exchange rate is the rate at
which one country’s currency is
exchanged for the currency of another
country.  These rates are reported daily
in the Wall Street Journal and many
other newspapers.  Current rates at
which the U.S. dollar is being traded
with other currencies such as the
Canadian dollar or the British pound can
also be readily obtained on Internet sites
such as:
http://moneycentral.msn.com/investor/m
arket/rates.asp.    
Bilateral exchange rates are typically
reported in two ways:
Contact:
Vincent H. Smith
(406) 994-5615
uaevs@montana.edu a.         The foreign currency price of
one unit of the home
currency.  For example, on
September 16, 2003 the
closing price of one U.S.
dollar in terms of Canadian
dollars was $C 1.369.  This
means that $US 1 could be
exchanged for $C 1.369.
b.         The home currency price of
one unit of the foreign
currency.  For example, on
September 16, 2003 the
closing price of one Canadian
dollar in terms U.S. dollars
was $US 0.7306.  This means
that $C 1 could be exchanged
for $US 0.7306.
Summary Indices
Summary indices of the value of a
country’s currency are similar to
price indexes.  Their purpose is to
show the average value (or price
level) of a country’s currency in
relation to several other currencies. 
In an arbitrary base period or year,
the summary index of a currency’s
value is assigned a value of 100.  In
subsequent years, the currency’s
average value is reported as an index
number relative to that base period.  
For example, in January 1997, the
broad summary index for the value of
the U.S. dollar was set at 100.  In
October 2002, the broad summary
index for the U.S dollar had increased
to 127.63, implying that on average
the U.S. dollar had increased in value
by over 27 percent over a period of
about six years.  In May 2003, the
broad summary index for the U.S.
dollar had fallen to 118.54 implying
that over the eight-month period from
October 2002 to May 2003, the U.S.
dollar had fallen in value by about 7
percent.
Changes in Currency Values
Currencies can increase (appreciate)
or decrease (depreciate) in value.  
A currency appreciation of the U.S.
dollar occurs when the foreign
currency price of the U.S. dollar
increases.  For example, on January
30, 2000, the Canada-U.S. exchange
rate was $C 1.4482.  By January 31,
2002, the value of the U.S. dollar had
increased to $C 1.5996, an
appreciation of 10.5 percent in the
value of the U.S. dollar in terms of
Canadian dollars. This means that
over the two-year period the price of
$US 1 increased by about 16
Canadian cents.
A currency depreciation of the U.S.
dollar occurs when the foreign
currency price of the U.S. dollar
decreases.  For example, on
December 31, 2002, the Canada-U.S.
exchange rate was $C 1.5591.  By
May 31, 2003, it had declined to $C
1.3833, an 11.3 percent decrease in
the value of the U.S. dollar.  This
means that over that five month
period, the price of $US 1 decreased
by about 17.5 Canadian cents.
Implications of Changes in the
Value of a Country’s Currency
The foreign currency price of the
U.S. dollar changes from day-to-day. 
Usually, day-to-day changes are very
small (most often less than one cent
in either direction).  Over a period of
several weeks or months, however, a
currency’s value can rise or fall quite
substantially.  The short-term effects
of such changes can be important for
agricultural commodity prices in
either one or both countries, as is
illustrated by the following example.
Suppose that the U.S. dollar price of a
bushel of wheat is valued at $US
5.00.  If the U.S./Canadian exchange
rate is $C 1.60 per U.S. dollar, then
the price of wheat in terms of
Canadian dollars will be about $C
8.00  ($US 5.00 * $C 1.60).  If the
U.S. dollar depreciates and is
subsequently traded for $C 1.40, then
the Canadian dollar price of wheat
will become $C 7.00 ($US 5.00* $C
1.40).  This represents a large
decrease in the Canadian dollar price
received by the Canadian Wheat
Board (the sole exporter of Canadian
wheat) and implies a lower Canadian
dollar price for Canadian wheat
producers.  Generally, when a
country’s currency appreciates
(increases in value) prices paid by
domestic consumers for commodities
that are traded with other countries
fall.  Similarly, when a country’s
currency depreciates, prices paid by
domestic consumers for commodities
that are traded with other countries
rise.
The long-term consequences of
changes in exchange rates are more
difficult to assess.  Often, substantial
changes in the foreign exchange rate
for a country’s currency are the result
of differing rates of inflation among
countries.  Suppose, for example, that
Canada has higher domestic inflation
than the United States (as was the
situation in the 1980s).  At a fixed
exchange rate between the Canadian
dollar and the U.S. dollar, prices of
similar goods will rise more quickly
in Canada than in the United States. 
This makes Canadian products less
attractive than their U.S. counterparts
to both Canadian and U.S. consumers
while U.S. products become more
attractive.  As a result U.S.
consumers will purchase fewer
Canadian goods and Canadian
consumers will purchase more U.S
goods.   So, the demand for U.S.
dollars by Canadian consumers
wanting to buy U.S. goods will rise. 
At the same time, the supply of U.S.
dollars offered by U.S. consumers
wanting to buy Canadian goods will
fall.  This will cause the price of U.S.
dollars in terms of Canadian currency
to increase.  Typically, over time the
Canadian price of U.S dollars will
increase by about the percentage
difference between the higher
Canadian inflation rate and the lower
U.S inflation rate to reestablish the
purchasing power of each currency.    
What does this mean for a typical
agricultural producer in eachcountry?  Suppose domestic inflation
results in more rapid increases in an
agricultural producer’s costs in one
country (measured in terms of the
home currency) than in another
country.  For a commodity that is
tradable, the exchange rate will
decline and cause the domestic price
of the commodity to increase by
about the difference in the two
country’s inflation rates.  A
producer’s relative competitive
position in domestic and international
markets is essentially unchanged. 
What Determines the Value of the
U.S. Dollar
The supply of and demand for U.S.
dollars in international currency
markets determines the value of the
U.S dollar.  Key factors that affect the
supply of and demand for U.S.
dollars include:
! Levels of U.S exports and
imports.  An increase in
exports causes an increase in
the demand for U.S. dollars. 
An increase in imports causes
an increase in the supply of
U.S. dollars
! U.S interest rates relative to
interest rates in other
countries and regions with
large and relatively stable
economies such as Japan and
the European Union.  An
increase in U.S. interest rates
reduces incentives for U.S.
citizens and business to
invest in financial assets
abroad.  This reduces the
supply of U.S. dollars on
international currency
markets. At the same time,
the increase in U.S. interest
rates increases incentives for
citizens and businesses in
other countries to invest in
financial assets in the United
States.  This increases the
demand for U.S. dollars.
  
! The U.S inflation rate
compared to inflation rates in
other countries.  When the
inflation rate in the United
States is lower than in other
countries, the real or “after-
adjusting-for-inflation”
returns to investing in the
United States will be higher. 
In addition, U.S. goods will
become more attractive to
both foreign and domestic
consumers, reducing imports
and increasing exports.  As a
result, the demand for U.S.
dollars will increase and the
supply of U.S. dollars will
fall. 
Long Run and Short Run Trends
in the Value of the U.S. Dollar
Longer run movements in the U.S./
Canadian exchange rate and the value
of the U.S. dollar in terms of a broad
summary index of other currencies
are presented in Figure 1 for the
period 1982-2002.  Over this period,
the U.S. dollar appreciated in value
vis`-a-vis` the Canadian dollar. 
However its value vis`-a-vis` other
currencies fluctuated considerably,
increasing between 1982 and 1986,
falling between 1986 and 1992, and
then increasing again over the next
ten years.  
More recent shorter run month-to-
month movements in the Canada-U.S.
exchange rate and the summary index
of the value of the U.S. dollar are
presented in Figure 2 for the period
January 2000 - May 2003.  Between
January 2000 and May 2003, the
value of the U.S. dollar against the
Canadian dollar and the general
summary index of the value of the
U.S. dollar followed very similar
paths.  Between January 2000 and
February 2002, the U.S. dollar
appreciated on a fairly steady basis
but between December 2002 and May
2003 its value fell sharply.
One important reason for the recent
depreciation of the U.S. dollar was
the emergence of a substantial gap
between interest rates in regions such
as the European Union and the
United States, mainly because of
decreases in U.S. interest rates to
forty year lows in late 2002 and early
2003.  This encouraged financial
investors to move funds out of the
United States to other financial
centers around the world, reducing
the demand for U.S. dollars and
increasing the supply of U.S. dollars
on international currency markets.
Summary
The values of world currencies
change daily.  Market forces that alter
the demand for and supply of U.S.
dollars cause changes in the value of
the U.S. dollar.  There is no reason to
expect the U.S. dollar to trade for
other currencies on a one-to-one
basis, even when those other
currencies have similar or identical
names.  In the long run, bilateral
exchange rate movements (the price
on one country’s currency in terms of
another country’s currency) are
largely driven by differences in
domestic inflation rates in the two
countries.  In the shorter run, other
factors such as changes in relative
interest rates, productivity and
imports versus exports are important
determinants of the value of the U.S.
dollar.Figure 1
U.S.-Canada and U.S. Broad Index Exchange Rates: 1982-2002 (Annual Data)
0.0000
0.2000
0.4000
0.6000
0.8000
1.0000
1.2000
1.4000
1.6000
1.8000
1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
$
C
a
n
0.0
20.0
40.0
60.0
80.0
100.0
120.0
140.0
B
r
o
a
d
 
I
n
d
e
x
Broad Index of U.S. Dollar's value U.S>- Canada Exchange Rate
Figure 2
The Value of the U.S. Dollar versus the Canada Dollar and an Index of All Currencies: January 2000-May 
2003
105
110
115
120
125
130
135
31-Jan-00 30-Jun-00 30-Nov-00 30-Apr-01 30-Sep-01 28-Feb-02 31-Jul-02 31-Dec-02 31-May-03
1.25
1.3
1.35
1.4
1.45
1.5
1.55
1.6
1.65
Canada-US Exchange Rate Broad Index of US $ Value
The programs of the MSU Extension Service are available to all people regardless of race, color, national origin, gender, religion, age,
disability, political beliefs, sexual orientation, and marital or family status.  Issued in furtherance of cooperative extension work in
agriculture and home economics, acts of May 8 and June 30, 1914, in cooperation with the U.S. Department of Agriculture, LeRoy
Luft, Interim Vice Provost and Director, Extension Service, Montana State University, Bozeman, MT 59717.

U.S. and Canadian Currency Values and Exchange Rates

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