(April 24 – 14:20 ET) – Policies that promote strong, sustained economic growth are the key to improving the health of the beleaguered Canadian dollar, say TD economists in their latest report, The Penny Drops.

“The weak Canadian dollar is not what is wrong with the Canadian economy. The weak Canadian dollar is a reflection of a series of conditions in the Canadian economy that are less attractive to investors than the situation in the United States,” says Don Drummond, senior vice president and chief economist of TD Bank Financial Group.

The TD Economics study suggests that there are no “quick fixes” to strengthen the Canadian dollar. The only direct tool the Bank of Canada has to boost the value of the Canadian dollar is to raise interest rates above U.S. levels.

However, the study concludes that markets might interpret such a move as lowering economic growth prospects in Canada — resulting in a weaker, rather than a stronger Canadian dollar.

TD Economics says recent fiscal progress means Canada is no longer on the verge of a confidence crisis. Hence, it is unlikely that any statements or actions by the fiscal authorities could give an immediate and substantial boost to the currency.

According to Drummond, “the only sure way to strengthen the Canadian dollar is to reverse the influences under our control that have caused the weakness. That requires a policy framework that promotes faster Canadian economic growth over the long term. While a sudden and sharp strengthening of the Canadian dollar is not likely, appropriate policies should raise its value over time.”

These policies include:

  • Bringing down the government debt burden faster;
  • Continuing to lower personal and corporate income tax rates;
  • Eliminating capital taxes;
  • Eliminating withholding taxes on investment income flowing out of and into Canada;
  • Keeping a tight rein on government spending; and
  • Shifting the tax burden toward consumption and away from saving/investment.

The TD Economics study also examines alternatives to the current floating exchange rate. It concludes that U.S. dollarization would, in the long run, be the only viable option. However, as it would require Canada ceding all control over its monetary policy and interest rates to the United States, this option raises difficult questions. Ironically, the study suggests dollarization would be a more realistic solution if the Canadian dollar were stronger.

There may be a day when it is clear that the Canadian and U.S. economic structures have converged sufficiently that there is little advantage to preserving the floating rate Canadian dollar. If so, Canada would have to give very serious thought to dollarization. However, TD Economics concludes that this at least a decade or two away. It says the appropriate solution to loonie’s current woes is to enhance the Canadian economy’s growth prospects.