Big Macs and oil: What do they say about the Canadian dollar?

Our FCC Ag Economist blog has often emphasized the importance of the Canadian dollar on Canadian farm income. We also recently discussed the value of the Canadian dollar in relation to the health of the Canadian economy. A frequent question we often receive is: “Will the Canadian dollar climb or fall relative to the U.S. dollar?”

There are a number of different ways to project the future value of the Canadian dollar relative to the U.S. dollar. Let’s focus on two fairly different approaches: The Economist’s Big Mac index and the historical relationship between oil and the dollar.

The Big Mac says the loonie is slightly undervalued

McDonalds Big Mac, by design is a standard commodity around the world. The price of a Big Mac in Canada and the U.S. should be fairly identical, or at least evolve slowly to the same price when expressed in the same currency.

In The Economist’s recent Big Mac survey, the average price of a Big Mac in the U.S. was US $5.04 and the average price was $6.00 in Canada. With the Canadian dollar trading at $0.77 U.S. the Big Mac Index would suggest that the Canadian dollar is undervalued by approximately nine per cent relative to the U.S. dollar. This index would suggest that Canadian dollar will eventually appreciate, perhaps to as much as US $0.84.

Oil tells a different story

While the Burger-economics is a fun way to look at currency valuations, there are a number of other external factors that can come into play. For example, the price of burgers could climb in the U.S., driven by higher income and strong demand for retail foods. A better way to gauge the value of the loonie is to analyse the historical relationship between the Canadian and U.S. dollar relative to the price of oil. Oil export receipts matter a great deal to the Canadian economy. Its price also indicative of the strength of demand for the commodities Canada offers in global markets.

The relationship suggests that the loonie is approximately one per cent higher than what it should be, therefore appropriately valued relative to the U.S. dollar. Future movements in the exchange rate should match movements in the price of oil.

A low Canadian dollar influences the price of agricultural commodities and farm inputs. We’ve given you two very simple indicators to help you project costs and receipts and obviously neither is perfect. In reality, the future path of the Canadian dollar rests on the strength of the world economy relative to our own. And that’s a far more complex discussion.