Who sells Canadian dollars

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Gary Rabbior is the president of the Canadian Foundation for Economic Education. This is the third part of a four-part series on understanding the Canadian dollar.

Let's consider who sells Canadian dollars and who both buys and sells.

Canadians buying imports

When Canadians want to buy products and services from other countries, they need to buy the currencies that those other countries will accept as payment. For example, if we import from Japan, the Japanese seller will want to receive Japanese yen - so Canadian dollars will have to be sold to buy the yen needed. The Japanese seller may also accept U.S. dollars since the U.S dollar has often served as somewhat of an international currency and has often been accepted as payment internationally. (There is some question as to whether or not that will continue to be the case in the future).

It is important to note that it is not only consumer goods that are purchased as imports. Many businesses will buy imported products, equipment, machinery, and technology. This also leads to the selling of Canadian dollars to buy other currencies in foreign exchange markets.

Canadians investing in other countries - and those losing confidence in the value of the Canadian dollar

Just as those wanting to invest in Canada need to buy Canadian dollars, if Canadians invest abroad, they will need to buy foreign currencies. If a Canadian wants to invest in U.S. real estate or Japanese stocks or buy a company in Argentina, Canadian dollars will be sold to buy the currency of the country where they are investing.

In addition, if investors begin to lose confidence in the prospects for Canada's economy, they may start to sell Canadian dollars and buy the currencies of other countries whose economies they believe are stronger - or will be getting stronger. This can lead to more selling of the Canadian dollar and put downward pressure on its value.

Returns to foreign investors and lenders

Interest and dividends will need to be paid to those who have invested in Canada and to those who have provided loans - for example, to Canadian companies, Canadian governments, and so on. To pay the interest and dividends, Canadian dollars will have to be sold to buy the currencies needed.

Speculators who think the value of the dollar will fall

Just as speculators will buy the Canadian dollar if they think its value will rise, they will also look to sell the Canadian dollar if they think its value is going to fall. For example, if they think the value of the dollar will fall against the Japanese yen, they can sell Canadian dollars, buy Japanese yen, and then, should the Canadian dollar's value fall against the yen, they can use the yen to buy back even more Canadian dollars in the future - and make a positive return on their speculation.

One thing to remember though is that speculation is just that. You are basically placing a bet on the direction you think a country's currency is headed. If you are right, you can make money. If you are wrong, you will lose money. That is the characteristic of all speculative activity.

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The Bank of Canada - and other central banks

This is one important group that can be both buyers and sellers of a currency.

The Bank of Canada's primary job is to try to influence monetary conditions in Canada so that we have a stable economy that operates close to or at its potential with a capacity to continue to grow without unleashing inflationary pressures. The Bank wants consumers, investors, and savers to have confidence in the value of the dollar and not have to fear or contend with a currency that loses value due to inflation. Historically, the Bank has done this by influencing interest rates, monetary conditions and the level of spending in the economy.

The Bank has the ability to try to influence the exchange rate if it believes that the value of the Canadian dollar is changing in such a way that it is having a negative effect on the Canadian economy. The Bank can influence the value of our currency in a number of ways.

One way is for the Governor of the Bank to simply talk publicly about the Bank's concern regarding the value of the dollar, as Governor Mark Carney has been doing. The Governor has made it clear that he believes the dollar's value is higher than it should be - and higher than the economy warrants.

Speaking publicly and forcefully as he has, the Governor can have an effect because investors and speculators may believe the Bank will take action to help lower the value of the Canadian dollar. If they believe that, they will tend to sell dollars to try to make their gains before the value begins to fall. This selling of the Canadian dollar will help to bring down its value - which would be the Governor's goal.

The problem is that this has a limited effect - especially now when the Governor has virtually no room to lower interest rates as a tool to help lower the dollar's value. In the past, if the Bank wanted to help lower the value of the Canadian dollar, it could take steps to lower interest rates. Lower interest rates reduce the buying of the Canadian dollar by investors and speculators and helps to lower its value. However, with current interest rates already so low, this tool is really not available to the Bank right now.

One other option available to the Bank is to use Canadian dollars and sell them to buy up other currencies, gold, and so forth in foreign exchange markets. This will increase the supply of Canadian dollars in the foreign exchange markets and help to put some downward pressure on its value. This can also be problematic since more Canadian dollars in circulation can help to fuel future inflation - which is a concern for the Bank as well. However, there appears to be little inflationary risk at the moment, so selling dollars to buy other currencies and commodities is an option the Bank can consider to help lower the dollar's value.

But, in reality, this only "leans against the wind," as they say, because if globally people want to buy Canadian dollars, it is hard for the Bank to counter the global buying pressure that is working to push the dollar's value higher.

On the other hand, if the Bank thought the value of the dollar was lower than it should be - and lower than was appropriate for the Canadian economy - it can use foreign reserves (U.S. dollars, gold, euros, and so on) to buy up Canadian dollars. This will help to put some upward pressure on the dollar's value.

Once again, though, the Bank can usually only try to spur some buying because, if global sellers are pushing the Canadian dollar lower, it is hard for the Bank to counter that force.

So the Bank of Canada can be both a buyer and a seller of Canadian dollars - depending on what the Bank regards as an appropriate range for the dollar's value.

In the final part of this series on Friday, we will look at why the loonie has been rising and volatile lately.