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Oil Bust Drags Canadian Dollar to Historic Lows [Chart]

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Oil Bust Drags Canadian Dollar to Historic Lows [Chart]

Oil Bust Drags Canadian Dollar to Historic Lows [Chart]

“Lower for longer” means loonie could hit US$0.59 by end of 2016

The Chart of the Week is a weekly Visual Capitalist feature on Fridays.

The continued pressure on the oil sector is wreaking havoc on the Canadian dollar.

This morning, the Loonie continued its freefall by losing another -1.1% , bringing the current exchange-rate to US$0.69. It’s the first time the Canadian dollar has traded below US$0.70 in 13 years, but the damage could be even worse.

David Doyle, a top forecaster for Macquarie Capital Markets, lowered his projection for 2016 to have the loonie finish at US$0.59. This would eclipse the all-time low for Canadian dollar, which was set on Jan 21, 2002, at just below US$0.62.

“Lower for Longer”

In this week’s chart, we show the well-established relationship between the Canadian dollar and the price of oil. Both prices have moved in tandem since 2000, and they’ve also both nosedived since the collapse of oil prices in mid-2014.

In fact, it may not surprise you to know that there are traders out there who use the Canadian dollar as a proxy for oil prices. If they think oil is going lower, they’ll sell Canadian dollars if it offers them the right kind of market exposure.

Oil is now trading at its lowest price since 2004, and many analysts believe that the pressure on prices will continue. Pundits are talking $20 oil and even $10 oil. While it’s very possible neither of those thresholds are reached, what is known is that low oil prices mean the Canadian dollar will continue to be under duress.

However, what are the specifics of this relationship? Canada is surely an economy that has a heavier reliance on raw materials, but it is no Saudi Arabia, right?

The Relationship Between Oil and the Canadian Dollar

The key to this relationship is based on two major principles.

Firstly, while Canada is a major producer of oil, it also exports the majority of this production to the United States. In 2014, Canada produced 4.4 million barrels of oil and equivalents per day, and it exported 3.4 million of this to the United States. Billions of US dollars are changing hands between American buyers and Canadian producers.

Oil prices are mostly traded in US dollars, which means that as the price drops, there are less US dollars being paid out to Canadian producers. This means producers are exchanging fewer US dollars for the Canadian dollars they need to pay wages and production costs. This drops the amount of “demand” for Canadian dollars, which affects the price of the currency.

Lastly, because oil is denominated in US dollars, the above effect gets further amplified by any other changes to the USD/CAD relationship. For example, while Canada has been loosening its monetary policy, the United States has been trying to do the opposite. This, along with other factors, has led to strength in the US dollar.

A strong dollar means cheaper oil. Cheaper oil means lower demand for Canadian dollars.

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The World’s Most Powerful Reserve Currencies

Here are the reserve currencies that the world’s central banks hold onto for a rainy day.

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The World’s Most Powerful Reserve Currencies

When we think of network effects, we’re usually thinking of them in the context of technology and Metcalfe’s Law.

Metcalfe’s Law states that the more users that a network has, the more valuable it is to those users. It’s a powerful idea that is exploited by companies like LinkedIn, Airbnb, or Uber — all companies that provide a more beneficial service as their networks gain more nodes.

But network effects don’t apply just to technology and related fields.

In the financial sector, for example, stock exchanges grow in utility when they have more buyers, sellers, and volume. Likewise, in international finance, a currency can become increasingly entrenched when it’s accepted, used, and trusted all over the world.

What’s a Reserve Currency?

Today’s visualization comes to us from HowMuch.net, and it breaks down foreign reserves held by countries — but what is a reserve currency, anyways?

In essence, reserve currencies (i.e. U.S. dollar, pound sterling, euro, etc.) are held on to by central banks for the following major reasons:

  • To maintain a stable exchange rate for the domestic currency
  • To ensure liquidity in the case of an economic or political crisis
  • To provide confidence to international buyers and foreign investors
  • To fulfill international obligations, such as paying down debt
  • To diversify central bank portfolios, reducing overall risk

Not surprisingly, central banks benefit the most from stockpiling widely-held reserve currencies such as the U.S. dollar or the euro.

Because these currencies are accepted almost everywhere, they provide third-parties with extra confidence and perceived liquidity. This is a network effect that snowballs from the growing use of a particular reserve currency over others.

Reserve Currencies Over Time

Here is how the usage of reserve currencies has evolved over the last 15 years:

Currency composition of official foreign exchange reserves (2004-2019)
🇺🇸 U.S. Dollar 🇪🇺 Euro🇯🇵 Japanese Yen🇬🇧 Pound Sterling 🌐 Other
200465.5%24.7%4.3%3.5%2.0%
200962.1%27.7%2.9%4.3%3.0%
201465.1%21.2%3.5%3.7%6.5%
201961.8%20.2%5.3%4.5%8.2%

Over this timeframe, there have been small ups and downs in most reserve currencies.

Today, the U.S. dollar is the world’s most powerful reserve currency, making up over 61% of foreign reserves. The dollar gets an extensive network effect from its use abroad, and this translates into several advantages for the multi-trillion dollar U.S. economy.

The euro, yen, and pound sterling are the other mainstay reserve currencies, adding up to roughly 30% of foreign reserves.

Finally, the most peculiar data series above is “Other”, which grew from 2.0% to 8.4% of worldwide foreign reserves over the last 15 years. This bucket includes the Canadian dollar, the Australian dollar, the Swiss franc, and the Chinese renminbi.

Accepted Everywhere?

There have been rumblings in the media for decades now about the rise of the Chinese renminbi as a potential new challenger on the reserve currency front.

While there are still big structural problems that will prevent this from happening as fast as some may expect, the currency is still on the rise internationally.

What will the composition of global foreign reserves look like in another 15 years?

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Currency

Why Gold is Money: A Periodic Perspective

Gold has been used as money for millennia. People often attribute this to beauty, but there are basic physical properties for why gold is money.

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Why Gold is Money

The economist John Maynard Keynes famously called gold a “barbarous relic”, suggesting that its usefulness as money is an artifact of the past. In an era filled with cashless transactions and hundreds of cryptocurrencies, this statement seems truer today than in Keynes’ time.

However, gold also possesses elemental properties that has made it an ideal metal for money throughout history.

Sanat Kumar, a chemical engineer from Columbia University, broke down the periodic table to show why gold has been used as a monetary metal for thousands of years.

The Periodic Table

The periodic table organizes 118 elements in rows by increasing atomic number (periods) and columns (groups) with similar electron configurations.

Just as in today’s animation, let’s apply the process of elimination to the periodic table to see why gold is money:

  • Gases and Liquids
    Noble gases (such as argon and helium), as well as elements such as hydrogen, nitrogen, oxygen, fluorine and chlorine are gaseous at room temperature and standard pressure. Meanwhile, mercury and bromine are liquids. As a form of money, these are implausible and impractical.
  • Lanthanides and Actinides
    Next, lanthanides and actinides are both generally elements that can decay and become radioactive. If you were to carry these around in your pocket they could irradiate or poison you.
  • Alkali and Alkaline-Earth Metals
    Alkali and alkaline earth metals are located on the left-hand side of the periodic table, and are highly reactive at standard pressure and room temperature. Some can even burst into flames.
  • Transition, Post Transition Metals, and Metalloids
    There are about 30 elements that are solid, nonflammable, and nontoxic. For an element to be used as money it needs to be rare, but not too rare. Nickel and copper, for example, are found throughout the Earth’s crust in relative abundance.
  • Super Rare and Synthetic Elements
    Osmium only exists in the Earth’s crust from meteorites. Meanwhile, synthetic elements such as rutherfordium and nihonium must be created in a laboratory.

Once the above elements are eliminated, there are only five precious metals left: platinum, palladium, rhodium, silver and gold. People have used silver as money, but it tarnishes over time. Rhodium and palladium are more recent discoveries, with limited historical uses.

Platinum and gold are the remaining elements. Platinum’s extremely high melting point would require a furnace of the Gods to melt back in ancient times, making it impractical. This leaves us with gold. It melts at a lower temperature and is malleable, making it easy to work with.

Gold as Money

Gold does not dissipate into the atmosphere, it does not burst into flames, and it does not poison or irradiate the holder. It is rare enough to make it difficult to overproduce and malleable to mint into coins, bars, and bricks. Civilizations have consistently used gold as a material of value.

Perhaps modern societies would be well-served by looking at the properties of gold, to see why it has served as money for millennia, especially when someone’s wealth could disappear in a click.

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