Why can currency depreciation be beneficial?

If the Canadian dollar goes down in value, other people want more of it. Other countries are more willing to buy Canadian goods as they have become more affordable. This means that currency depreciation fundamentally is not a bad thing.

Just like sellers don't look at the lowering of their prices to be harmful, the lowering of a currency is on the international scale kind of a "lowering of the prices of the whole country's products."

Why do we intuitively regard the depreciation of currency as negative?

For me, I think it's because of my family's financial ties. In 2011, one Canadian dollar was worth 7 Chinese Yuan. At that time, my family converted the 1million+ of yuan into CAD, getting maybe 200k CAD. 7 years later, 1 CAD is only 5 yuan. Because the Chinese currency was worth less when we converted it, we lost out on a lot of potential canadian dollars than if instead, we converted it a few years later.

Furthermore, Canadian dollars, where all my money currently lies, has also depreciated against USD, making US tuition more expensive, costing me more of that sweet sweet cash. The reason that I had believed intuitively my whole life that a depreciating currency is objectively harmful is that it does the same thing as inflation - lowering your purchasing power. I used to be able to buy a US pizza for $10, but now, with the depreciated Canadian dollar, I need to spend $12.5 to get the exact same product. More money spent to acquire the same thing - seems intuitive that a depreciating currency is damaging to a country.

Demand for a country's currency is driven by the country's exports. The demand curve measures, for example, how much do Americans want the Canadian dollar? In order for US citizens to buy Canadian goods, they first have to convert their cash into Canadian dollars, hence, they want our currency. Similarly, the supply of a country's currency is governed by its imports - to buy another country's products, one must sell their domestic currency, hence, increasing the supply.



Combined, this demand and supply curve govern the price of exchange rates. This is exactly the same as how the demand and supply for a product govern the price of goods in the free market.

If a depreciating currency is bad, that is equal to saying a firm having low prices is bad for the firm, yet intuitively we don't see it that way. Instead, intuitively, we feel that well, if Apple lowered the cost of their overpriced designer phones, they'll be able to sell more, which balances out the price. If a firm has lower prices you can say that its relative "purchasing power" has decreased relative to the rest of the firms, that each iPhone is able trade you fewer Samsungs, just like the intuition behind why decreasing exchange rates is bad for a country. It's a delicate balance between lowering prices and maximizing goods sold - it's not that lower or higher prices for the firm is strictly better, it's about finding the equilibirum.

This is just like exchange rates - it's not that a lower or higher value of Canadian dollars is objectively better for the country. It's about balance. It's about having the exchange rate oscillating back and forth until equilibrium is reached, the invisible hand setting the floating exchange rate just like how it sets the prices of products in a free market.



This helps with intuition on why depreciating exchange rates isn't strictly detrimental.



Why is the pesky CAD goinmg down in value? I will go on a drive through maco-con-land to find out. I am determined to get to the bottom of why I have to pay extra for US university tuition.

Suspect #1: Interest rates

If Canada interest rates go down (or if US interest rates go up), less US investors want to put their money in Canadian investments because they'll get less return.



Canadian investors would want to put their money into a country with better interest rates, hence, put their investments into the US, increasing supply of CAD on the forex market.



Note: the exchange of foreign investments is known as capital inflow/outflow and is recorded in the captial account. (You don't need to know this vocab, but I do, so that's why I'm writing 'em.)

Suspect #2: Trade Balance

If Canadians love USA goods, they'll buy more, increasnig supply of CAD. If USA hates canadian goods, will buy less, decreasing the demand for canadian dollars. Both lead to the depreciation.



canada buying more uSA goods than they buy ours is a trade defiict for Canada. So CA has trade deficit = CA currency depreciates.

Note: The trade balance (the deficit or surplus) is recorded in the current account.

Suspect #3: Income

If Canadians have higher income, they'll buy more foreign goods, increasing supply of CAD.

If USA has lower rincome, they will buy less Canadian goods because they can't afford it, reducing the demand for CAD.

Both an increase of supply and reduction in demand causes CAD to depreciate.



Suspect #4: Inflation

If the price level of Canada rises, then each Canadian dollar is able to buy less domestic goods. Domestic Candian goods will be more expensive. USA does not like this expensive, so demand of CA exports go down and thus demand for CAD goes down.



Suspect #5: Speculation, consumer preferences, and other human quirks

Ultimately, any factor that causes Americans to want less of Canadian goods or investments will lower the value of the Canadian dollar. If Americans decide that they don't like poutine and Quebec's baugettes anymore, then they will buy less Canadian exports and the demand for the Canadian dollar will go down. If Americans speculate that the Canadian dollar will depreciate soon, they will take their money out of Canadian bonds, which also shifts the demand curve to the left.



In this sense, economic speculation is a self fulfilling prophecy.



Back to reality, away from the econ-theory-land...

I doubt the real culprit is income. Canadians having higher income than the US? Pffft unlikely.

What about the trade balance? According to the United States Census Bureau, who publically releases all trade data, there wasn't one year since 2011 where Canada imported more than it exported from the United States. However, the trade is roughly balanced, with Canada's trade surplus in the thirty thousands at most.

For instance, here's what Canadian-US trade looked like in 2020. The numbers are from the US perspective, so I flipped the import/export labels to consider Canada's perspective.



Is the culprit interest rates? Canada did have slightly lower interest rates than the states in the past 4-5 years.



(Image and data sources: US, Canada)

What about inflation? Has the price level in Canada increased in the past 10 years?



(Image and data sources: US, Canada)

Canada's inflation rate is generally slightly lower, except the dip in 2015. and 2015 is also when we saw a hike in exchange rates!



(Image source)

Does this correlation imply causation? I can't say for sure. There are probably many factors at play that the basic macroeconomic theory does not cover.