The Trump Tariff War and the Canadian Dollar's Existential Threat

Strategic Insights -

The Trump administration's attempt to reduce the U.S. trade deficit through tariffs and a weaker dollar has sparked concerns about the impact on the Canadian dollar, with some economists warning that the loonie is at risk of destabilization. The Bank of Canada has traditionally allowed the exchange rate to float, serving as a shock absorber against economic shocks. However, this approach may not be sufficient in the face of a large and unpredictable trade war. Canadian policy makers must now grapple with the implications of a weakened U.S. dollar and the potential for the loonie to become more volatile.

Key Takeaways:

  • The U.S. dollar accounts for almost 60% of all foreign currency reserves held by international central banks and other financial institutions, according to the IMF.
  • A devalued U.S. dollar could lead to a surge in demand for the loonie, making it potentially more volatile.
  • The Bank of Canada has kept its foreign reserve powder dry, choosing not to intervene in currency markets to stabilize the exchange rate.
  • The Bank of Canada could consider fixing the exchange rate to the U.S. dollar, but this would relinquish control and make Canada more vulnerable to external shocks.
  • Other countries, such as China, have taken a Goldilocks approach, intervening in currency markets to manage their exchange rates within a desired band.
  • The Canadian government needs to get serious about diversifying international trade and bolstering private-sector productivity to mitigate the impact of a weakened U.S. dollar.
  • The Canadian dollar has quietly become more widely held in international currency reserves, ranking sixth in terms of the size of all foreign reserve holdings.

Statistics:

  • The U.S. dollar accounts for almost 60% of all foreign currency reserves held by international central banks and other financial institutions.
  • Canada's foreign currency reserves stand at about US$126 billion, or roughly 5% of GDP.
  • The average foreign exchange reserve-to-GDP ratio for other advanced economies is about 13%.
  • The Canadian dollar is the sixth most widely held currency in international reserve holdings, after the U.S. dollar, the euro, the yen, and the pound.

Sources:

  • IMF: "Currency Composition of Official Foreign Exchange Reserves"
  • The New York Times: "U.S. Treasury Secretary Says Dollar's Pre-Eminent Status May Be a Burden"
  • The Financial Times: "Can the Dollar Remain King of Currencies?"
  • Hejazi, W. (in press). "The Role of the Canadian Dollar in the Trump Era: A Case Study." Canadian Public Policy
  • Lane, T. (interview). "The Impact of the Trump Tariff War on the Canadian Dollar."