One idea that seems to attract a lot of attention is that CAD/USD has been driven higher by the rise in the price of crude oil and the output from Alberta's Tar Sands (see for instance the comments in this blog: We are all Albertans - On est tous des Albertans). The idea is appealing as the dollar value of Canada's exports have clearly increased with the rise in the price of oil.
But exchange rate data doesn't generally support the idea that the rise in CAD/USD is due to the Canadian dollar strengthening, as compared to the US dollar weakening. In particular, if the rise in CAD/USD stemmed from the strengthening of the Canadian Dollar, then one should also see similar rises in the Canadian Dollar versus other currencies. Conversely, if the rise in CAD/USD has stemmed from USD falling, then one would expect to see USD fall against other currencies.
Below is a chart plotting the average monthly exchange rate for CAD/USD, CAD/EUR (Euro) and EUR/USD from January 1999*. Since 2002, both the Canadian dollar AND the Euro have strengthened considerably against the US Dollar (approximately 50% in both cases), but the Canadian Dollar versus the Euro has been flat (with some variance).
Now the Euro-area is a net importer of crude oil, and Canada (through the Albertan Tar Sands) is a net exporter. If the rise in the price of oil and output from Alberta was driving the Canadian dollar higher, then one would expect that CAD/EUR would rise? But the exchange rate has been flat (especially compared to the US crosses)There is also a great counter-example to the idea that the price of oil has been driving the Canadian dollar higher in this data set. In the first half of 2008 the price of oil rose from $100 to nearly $150 (marked with an arrow on the chart above). This was correlated with a sharp rise in the Euro to nearly USD 1.60. The Canadian dollar was flat during this period, as if the price of oil did not influence CAD.
Now obviously this is a simplistic approach to looking at exchange rates, but it is informative. Movement in the US dollar appears to be the primary driver in the CAD/USD exchange rate. Undoubtedly there are other feedback loops, such as a drop in USD leads to a rise in the price of oil, which helps Canada's trade balance. And perhaps if Canada was not exporting oil from the Alberta Tar Sands, CAD would have followed USD lower this past decade.
But it appears that,the Canadian dollar hasn't strengthened, it's the US dollar that has weakened.
Edit: Some numbers from the chart above
Let's look at the change in CAD/USD, CAD/EUR and EUR/USD from 2002 to 2008 (2008 saw the greatest appreciation in both currencies and crude oil). Below is the average exchange for each pair for each year, plus the percent change.
CAD/USD - 2002: 0.637, 2008: 0.943, change: +48%
EUR/USD - 2002: 0.945, 2008: 1.471, change: +56%
CAD/EUR - 2002: 0.676, 2008: 0.642, change: -5%
*Canadian dollar exchange rate data from Bank of Canada, Euro/USD exchange rate data from the ECB website. Euro/USD monthly exchange rates calculated as the average of the first 21 trading days from the start of the month.
