From July of 2014 to February of 2015 the Canada/US currency exchange rate plummeted from 1C$=U$0.94 to U$0.79 with the rapid drop in oil prices . . . a decline of 16% in just eight months. The carnage continued as the Canadian loonie bottomed out at U$0.69 in January of 2016 . . . another 13% over these 11 months. Overall, the Canadian loonie dropped almost 27% in about a year and a half, leaving many Canadians fretting about how much money they would lose if they converted to US dollars. But do you really lose money when you convert to another currency? This article will answer that question.
The short answer is…you don’t lose money when you exchange currencies. If you did, there would be a way to make money. For example, in January of 2016, 1C$=HK$5.37 which means for every Canadian loonie you hold, you would get 5.37 Hong Kong dollars. Just think, a mere C$186,220 would turn you into a Hong Kong millionaire! Look at all the money you just made. But did you?
Using the currency exchange rates above, let’s summarize:
1 Canadian dollar = 0.69 US dollars = 5.37 Hong Kong dollars
These are all currencies that use the name “dollars”. But that is where the problem lies; they all have the same name. An analogy may help to understand this troublesome issue. Imagine we use fruits instead of currencies. Now in Canada, you own 100,000 B.C. apples. We’ll use Florida grapefruits to represent the U.S. dollar and Chinese Lychees to represent the Hong Kong dollar.
Using our math above, if you have 100,000 Canadian apples and you convert them to U.S. grapefruits, you will have 69,000 grapefruits. So what did you lose? 31,000 apples? Well then let’s convert 100,000 apples into 537,000 lychees. So what did you gain? 437,000 apples? No, you didn’t gain or lose anything. You just traded for a different type of fruit.
The bottom line is even though they are all fruits, they are different fruits…you just own different amounts of each kind of fruit. When they are all named “dollars,” it can lead one to think we are talking about the same thing and therefore, we are losing and gaining accordingly. But we are not…we are talking about apples, grapefruits and lychees, which are all fruits, but different! Therefore, you did not lose or gain anything . . . you exchanged 100,000 apples for 69,000 grapefruits. Or, you exchanged 100,000 apples for 537,000 lychees.
If the currency you hold has been devalued in relation to another currency, you don’t lose money when you exchange the currency, the value of your currency has already been lost. What people are more concerned about when it comes to currency exchange is the loss of buying power. When the value of the Canadian loonie goes down in relation to the US dollar, you MAY lose buying power with your loonies. Why maybe? Because it depends on the pricing of products and services (various inflation rates) in the US. If you exchange your loonies for US dollars and then purchase goods in the US, is your buying power diminished. Possibly. There are many factors that go into the price of goods in a particular country. For example, if a bottle of water costs C$1.50 in Canada and U$1 in the U.S., you may not have lost any buying power. But if a bottle of water costs HK$1,000 in Hong Kong, you have lost buying power. See how that works?
This usually leads to another question: “What is the outlook for the Canadian loonie?” The bottom line is we don’t have a clue as we cannot predict the future. Investment research has shown that no one can accurately predict what is going to happen with any financial metric with any consistency. If we could, we would leverage our entire net worth to take advantage of it, and we would retire tomorrow.
There are just too many factors that go into the valuation of a currency, which are impossible to foresee. No one thought the United Kingdom would leave the European Union (Brexit). Even polls on the night of the vote showed a high likelihood that the UK would elect to stay in the EU. This caused the British Pound to drop 10% in one day in relation to the US dollar. Research by our firm shows a correlation between oil prices and the Canadian loonie. However, that would require the ability to predict the price of oil, which also cannot be done. If so, who saw the price of oil drop from $100 per barrel to $28 in as short of a time period as it did? And was it luck? Or skill? How do we know? By looking at the record of the predictor, which few are willing to share. We hope this helps clarify the loss and gain that occurs with currency exchange.
