Canada

Why the dollar is taking a nose dive

KEVIN DOYLE,HARTLEY STEWARD February 21 1977
Canada

Why the dollar is taking a nose dive

KEVIN DOYLE,HARTLEY STEWARD February 21 1977

Why the dollar is taking a nose dive

Canada

Marty Liebman is an unrepentant, honest-to-God gnome, one of those traditionally shadowy figures who operate in the mysterious world of international finance, making and losing fortunes by dealing in other people’s money. Right now. Liebman and his colleagues in the rumor-filled halls of the Chicago Mercantile Exchange are onto a very hot number—the usually staid and predictable Canadian dollar, which in the last three months has become one of the most buffeted currencies in the world. It has steadily lost value and, if most of the experts are right, the worst is yet to come, as money traders in such places as Chicago and London assess the future of Canada and the Canadian economy.

Money broker Liebman, for one, thinks something is wrong in Canada (“every time Trudeau or Lévesque open their mouths they say the dumbest things . . .”). While not sure of the problem, he’s convinced Canada’s dollar will tumble lower, something that could greatly increase his earnings. Since the Parti Québécois upset in the November 15 provincial election, the Canadian dollar has dropped from a level where it would buy nearly $1.04 U.S. to a point where it was worth scarcely more than 97 cents at mid-month. The election of Premier René Lévesque and investor uncertainty about the aims of his separatist government had a lot to do with the suddenness of the dollar’s dizzying drop, but there are far more substantial and subtle reasons for its longer-term erosion.

While trying to predict its future behavior is at best hazardous and at worst selfdefeating, leading members of Canadian and American financial communities are virtually unanimous in forecasting that it will not recover its former strength in the foreseeable future and that it will likely fall even further. Estimates of where it will settle vary from less than 75 cents U.S. to somewhere near its present level. For Canadians, who import about 25% of the goods they consume, the immediate implications are anything but pleasant, although just how unpleasant depends largely on how low the dollar actually goes. Should it eventually slide to, say, 93 cents—an assumption not considered farfetched by many international economists—the currency’s reduced purchasing power abroad would push import prices up by 11% to 12%, says Keith Dixon, executive vice-president of the Toronto-based Canadian Importers Association. If the increases were then passed on directly to consumers it would mean, for example, that a new Toyota Corolla 1600, with auto-

matic transmission, radio and rear window defroster, would cost an additional $438, selling for $ 4,421 instead of $3,983. A new 26-inch Sylvania console color TV, now costing $ 849, would increase by $93, and a Volkswagen Rabbit, which costs $4,935, would go up by $543. The great promise of a devalued dollar is that, by making Canadian goods cheaper abroad, it will eventually create an export-led economic revival, more jobs for Canadians and greater overall prosperity.

By far the most pessimistic of the money brokers is Nation-Wide Trading Company Limited, based in Toronto, which believes the dollar will go down to 75 cents U.S. Says Nation-Wide, which has a good track record in forecasting currency values: “It

would be foolhardy to believe that the Bank of Canada will be able to stabilize the [dollar] market in view of the fact that major U.S.-controlled corporations, along with the central banks of Western Europe, will be pounding the Canadian dollar in the months ahead.”

On the foreign exchange market, currencies behave like any other commodity; no more or less exotically than this year’s turnip crop. The dollar obeys the rules of supply and demand: if demand is high, so is the dollar. What is really going to happen to Canada and its economy is no more important in the money market than what traders and speculators think is going to happen. And many of those who do the thinking are foreigners with only a min-

imum knowledge about Canadian affairs.

The demand for the Canadian dollar has remained fairly strong for several years. And it is in the reasons for this demand that the crux of Canada’s dollar problem can be found. While there has been some demand for dollars by people wanting to buy Canadian goods, resources and services, that pressure alone was not enough to support the currency at its previous high level. Much of its support was a spin-off from record-high foreign borrowing by governments in Canada at all levels, by corporations and private industry. Most of the borrowing was done by issuing bonds on foreign markets, and in order to buy them foreigners needed Canadian funds. Says Bengt Gestrin, a vice-president of the Canadian Imperial Bank of Commerce: “If we stopped supporting the dollar by borrowing foreign funds, it would probably be at about 78 cents American.”

Few businessmen believe anything so drastic will happen but many are moving to minimize their risks. Lew Shoskes is probably typical. Vice-president of Panasonic in Toronto, a firm that imports small TV sets, tape recorders, stereos, component parts and related equipment, Shoskes says he’s optimistic about the dollar’s future, but he acknowledges that he doesn’t want to take too many chances. So he, like many other businessmen, arranges with a bank or works through a broker to buy American dollar futures. Using this arrangement, he agrees to buy U.S. dollars and pay for them at any time up to six

months or so in the future at a fixed price of, say, $1.05 Canadian to one dollar U.S. By operating constantly in this fashion, Shoskes and other businessmen can ensure themselves against situations where they have to exchange their Canadian currency at the “spot,” or day-to-day rates, should the dollar continue to slide. On the other end of such transactions are usually banks and big financial houses that can quietly and continuously buy and sell the funds they hold to maximize profits and avoid losses.

The men in the middle of these deadly serious deals are the Marty Liebmans of the world. Liebman and his partner, John Rasmussen, specialize in finding buyers and sellers for currencies under pressure, and on the Chicago exchange—the second biggest in the United States—in the “pit” reserved for Canadian dollar dealing he has found the hottest game in town. Says Liebman: “I think everybody was generally aware that the dollar was overvalued, but in the days after the Quebec election and after Lévesque’s speech in New York (made January 25 to the Economic Club of New York), people were falling over themselves to get out of Canadian dollars.”

What happened was that some Americans, who had bought Canadian dollars for delivery sometime in the future at a fixed exchange rate based on the currency’s previously high level, began to panic after the Lévesque election and wanted to sell their dollar contracts to anyone prepared to buy, even if it meant taking a loss. Many of the

sellers, says Liebman, are speculators, men who make their living by trying to determine which currencies are likely to increase in value and which ones are heading for a slide, then buying and selling accordingly. Others are businessmen who deal with Canadian firms and, like Shoskes, want to be certain of a stable rate of currency exchange in future transactions. As long as the dollar remained strong and steady, American businessmen had little need for such protection. Last October 15, for example, was a fairly typical day on the Chicago exchange. According to Liebman, only 49 Canadian dollar contracts were sold on the trading floor. But on November 16, the number of contracts sold—each worth $100,000—shot to 416, and on February 2 there were a stunning 1,188 sales.

The dollar’s rapid decline was, in the view of most international moneymen, long overdue. In 1970, the Canadian dollar was worth 92.5 cents U.S. Since then, Canadian costs have risen faster than those in the United States and productivity gains have lagged well behind those south of the border. But the Canadian dollar, which normally would have reflected these trends by losing value, actually gained strength, reaching a high of about $ 1.05 at its peak last year. Even the drain from a balance of payments deficit, which reached $4.7 billion in 1975 (last available figures) failed to have any appreciable effect before last November.

But what few people outside the tight circle of economists and financiers realized

at the time was that the impressive buoyancy of the dollar was due, in large measure, to Canada’s extraordinarily heavy borrowing abroad. The country’s total net external debt now stands at about $43 billion—among the largest in the world. Part of the explanation for this phenomenon is the relatively small size of the existing Canadian capital market. The federal and provincial governments also encouraged foreign borrowing for a variety of reasons, not the least of which was to keep the dollar strong. But a more important factor is that Canadian interest rates have been higher than those in the United States, making it fairly easy to offer attractive returns to investors in New York, where the bulk of the borrowed funds was raised.

Late last year, however, the rush to borrow began to wane and plans for this year indicate the provinces and private companies will settle for a relatively modest five billion dollars in foreign funds. At the same time that borrowers began reducing their demands, the Bank of Canada started lowering its pace-setting prime lending rate to 8% from 9.5%, making Canadian bond issues abroad much less attractive. The shock from the Quebec election quickly focused international attention on these problems.

The main advantage of a devalued dollar is that it makes Canadian exports, such as pulp and paper products,* minerals, and some manufactured goods, less expensive. Says Keith Dixon: “We are one of the few countries in the world that could export more than it imports. We’re in a most advantageous position now. Our resources and goods are in demand and our dollar is less than par with the American dollar. We don’t do it because our manufacturers are just too lazy.” Like Dixon, the federal government, too, would like to see a cheaper dollar leading to an export surge, which would generate more profits in the economy and, more importantly, create new jobs to ease Canada’s soaring 7.5% seasonally adjusted unemployment rate. Canada is already selling more goods abroad than it buys, but not nearly enough to offset the heavy drain on the overall balance of payments account caused by the outflow of funds needed to service the external debt and by Canadian tourists spending more overseas than foreigners spend here.

But there are difficult problems in the way of an export-led recovery. In the first place, it traditionally takes a year or more after a devaluation before cheaper exports lead to increased foreign demand. Meanwhile, the increased cost of imports—and its inflationary impact—is felt immediately, often tending to stir labor unions to demand compensating pay raises. In addition, the international economic outlook currently is extremely clouded, with

* Vancouver-based MacMillan Bloedel Ltd., Canada’s largest forest products company, claims, for example, that every one-cent drop in the Canadian dollar translates eventually into a $2.5 million increase in after-tax profits.

growth in Western Europe and Japan, two of the more lucrative markets for Cana dian goods, at a standstill, and with eco nomic expansion in the United States, Canada's biggest trading partner, showing only a fitful recovery from the recession. Ottawa, however, has little choice other than to rely on a strong American recovery with an accompanying surge in demand for Canadian goods. In the absence of in creased export demand, the federal gov ernnient is forced to rely heavily on lower ing interest rates (see graph) to generate borrowing in Canada for new investment. But this, in turn, can create its own di lemma. If interest rates drop much lower while they are rising in the United States, it makes Canadian bonds harder to sell, re ducing further the demand for Canadian dollars. Nevertheless, the federal govern ment and some economists seem fairly

confident (perhaps unrealistically so) that the pace of the U.S. recovery will quicken and that there will be no problem in raising the funds needed abroad. Even accepting gloomier forecasts, how ever, there seems little reason to expect the dollar will suffer the fate of, say, the British pound, which has been driven to roughly $1.70 from about $2.60 five years ago. The Bank of Canada has hefty foreign ex change reserves with which to buy dollars and the Canadian government could de cide to issue more bonds abroad and push up demand if a slide threatened to get out of control. But these are holding operations for the most part and, unless the markets and most economists are very wrong, the heady days, when a soaring Canadian dollar would buy you flstfuls of foreign currency at some of the most attractive rates in the world, are quickly giving way to more

KEVIN DOYLE

HARTLEY STEWARD