🎧 Why My Canadian Friend Ditched Our Trip to North Georgia for Cancun

And introduction to exchange rates, how raising interest rates affects exchange rates, how changing exchange rates changes the amount we import and export

The time stamp for the Conclusion is 5:09.

Vancouver, personal photo

In the US, we trade with each other in dollars. When we’re trading with a supplier outside the US, we must buy their goods in their currency. To do this we supply dollars.

When we’re trading with customers, they must buy our goods in US dollars. To do that, they demand dollars.

This sets up a market for dollars used in international exchange. We supply and demand US dollars. The price is the exchange rate for dollars in a particular country.

For example, one of the main goods we supply Canada is motor vehicles. We buy energy, like oil, natural gas, electricity, and uranium, from them. (We also supply oil to Canada.)

To exchange these goods, there is a market for US dollars there. There is also a market for Canadian dollars here. These currency exchange markets are what we call one-to-one. That is, there is a separate market for currency between the US and Canada, another market for currency between the US and the UK, etc.

Montreal’s side streets, personal photo

The exchange rate of US dollars to Canadian dollars varies over time. The first time we went to Canada to cruise from Montreal to Boston (2011), the exchange rate was high for us. It took about $1.20 US (1.20 USD) to buy one Canadian dollar (CAD). The second time, when we stayed in Vancouver before a trip to Alaska, it was one for one.

Since the Federal Reserve (the Fed) raised interest rates, the USD has been high (or strong) compared to the CAD. The current rate is 1 USD: 1.37 CAD.

What causes changes in exchange rates?

The Federal Reserve increased US interest rates by reducing the supply of dollars available in the US. If you read the Crash Course on Inflation (see link below), you learned that the Fed did this to reduce inflation.

Historically, when the Fed raises interest rates, this causes a greater demand for dollars abroad. The US dollar was, until recently, considered a haven for those living with less stable currencies. When the demand for dollars goes up, so does its value in international trade. For example, on our trip to Vancouver in 2013, one US dollar (1 USD) was about the same thing as one Canadian dollar (1 CAD).

Since the Fed raised interest rates, the value changed: 1 USD: 1.37 CAD. Our friend Linh from Toronto, chose to attend a wedding in Cancun, rather than pay for her usual trip to the North Georgia mountains with us. Not that I can blame her for wanting to visit Cancun (even in June), but part of the problem was the price of visiting the US in Canadian dollars.

Changes in exchange rates cause changes in the amount we export and import

Changes in exchange rates also cause changes in exports and imports. If the dollar is more expensive (goes up in value in relation to another country or gets stronger), then our goods are more expensive in that country.

At the same time, their goods are less expensive for us.

This causes our exports to others to fall and our imports from abroad to rise. A numerical comparison helps here. Keep in mind that I’m ignoring the fees for exchanging currency, taxes, shipping costs, and tariffs.

Suppose the initial price of one USD is one CAD, as it was when we visited Vancouver on our way to Alaska:

1 USD: 1 CAD

Then the price of a bottle of canola oil in the US is the same as it is in Canada, assuming no tariffs, fees, or charges for exchanging currency. Let’s say it is 3 CAD, then it is also 3 USD. The same for an American car priced at $30,000. It is also $30,000 in Canadian dollars.

But suppose the price of the dollar doubles in terms of the Canadian dollar. So now it takes 2 CAD to buy 1 USD.

1 USD: 2 CAD or 0.50 USD: 1 CAD

Now, the price of those goods differs too.

1.50 USD: 3 CAD.

(Multiply by three and divide by two—3/2.)

The price of the bottle of canola oil has fallen from 3 USD to 1.50 USD. The same will be true for all goods that we buy from Canada. Canadian goods are then cheaper, and we’ll import more.

Let’s look at the American car priced at $30,000. Now that price doubles in Canada.

30,000 USD: 60,000 CAD

Canadians would pay more for cars. Our exports would get more expensive, and they’d buy less. The same thing would happen to other goods we exported.

Conclusion

So, if the dollar rises in value, our goods get more expensive abroad and our exports will fall. Their goods would be less expensive, and our imports would increase.

The opposite would happen if the dollar fell in value against other currencies. Our exports would rise, and our imports would fall. The presence of tariffs affects only the prices of our imports, making them more expensive. But, if other countries do the same or prop up their currencies to counteract the tariff, then prices could go up for our exports too.

Next time, in our wrap-up post we’ll see how this affects GDP.

As always, thank you for reading,

Nikki

Crash Course on Inflation: https://nikkifinlay.substack.com/p/inflation-course-toc