COVER

Images vs. reality

PATRICIA BEST January 27 1986
COVER

Images vs. reality

PATRICIA BEST January 27 1986

For months the Canadian dollar had drifted slowly downward on world markets. Then, last week currency dealers on Wall Street, in the City of London and in Chicago suddenly decided to sell it in large amounts—and in a day of frenzied trading they drove it to a historic low point. For many Canadians the attack on the dollar was a rude shock. The country’s currency is a vital, valuable and powerful resource. And the general optimism about Canada’s economic prospects, buttressed by three years of economic improvement, has fostered the expectation that Canadian money should be worth more than it is in the United States and Europe. But to international money traders the dollar is simply a day-to-day speculative investment—and not a particularly important one. Said Thomas D’Aquino, president of the Ottawa-based Business Council on National Issues: “We are not dealing with rational forces. We are dealing with murmurs, rumors, speculation.”

Image: Coinciding with the selling was the appearance of articles in major U.S. publications earlier in the week drawing attention to what they described as the image problems of Brian Mulroney’s government. As well, the release of Canadian trade figures showed a sudden deterioration. And with prices for natural resource commodities still depressed, some foreign traders concluded that because of Canada’s large resource base, its economy was threatened. Detecting a weakness in the Canadian dollar, speculators on the international money market of the Chicago Mercantile Exchange moved in, selling large volumes of Canadian dollars and sending the currency tumbling.

One report that made traders noticeably nervous said that Canada and Italy had been frostily received when they had requested membership in the Group of Five nations which met in London last weekend to discuss lowering the U.S. dollar and interest rates. The report in The New York Times attributed the reason for the refusal to difficulties that Canada and Italy would have in putting monetary decisions taken by the group into effect, and one monetary official was quoted as saying, “We want members with real governments.” The reports and statistics created an unsteady image for the Canadian economy.

At the same time, the actual measurements of the Canadian economy are strong. Economists point to low inflation and unemployment rates, improved job creation, soaring corporate profits, higher productivity, steady consumer spending and increasingly active manufacturing as reasons why the dollar should be strong. Said James Frank, chief economist of the Conference Board of Canada: “It does not make sense.” For his part, Finance Minister Michael Wilson declared that the dollar was suffering only a temporary and minor setback. He told Maclean’s, “The fundamentals for the most part are very solid as far as Canada is concerned.” But he added: “Markets will move. Sometimes they will overreact to situations, sometimes they will react to perceptions of things rather than realities.” Indeed, Geoffrey Maynard, chief economist in the London office of the New York-based Chase Manhattan Bank, said that the money market “tends to overreact to what it perceives as political crises.”

But Liberal Opposition Leader John Turner said that the dollar’s fall was a result of the international community’s perception of the Mulroney government. Said Turner: “There seems nothing concrete to indicate why the Canadian dollar is falling except for one overwhelming reason. I believe the markets are saying that they have little confidence in the way this government is managing the country and managing our economy, and I think that is what is being reflected in the lower dollar.” As well, one senior New York currency trader cited the government’s unsuccessful attempt to rescue two Western banks last year as a factor influencing the dollar. For others, the lack of decisive action on Canada’s deficit triggered uneasiness. Said Andrew Alleyne, senior economist with the Toronto-Dominion Bank in Toronto: “Foreigners perceive that the government is not serious about reducing the deficit. The only way is if the Prime Minister throws his weight behind the finance minister, who is serious.”

Alarm: In New York traders said that reports of Mulroney’s indecisiveness on the budget contrasted sharply with the more determined actions of the U.S. government to deal with the same problem. Declared Thomas Robinson, an economist with Merrill Lynch in New York: “What has been building alarm for some time among investors is a belief that government came in with the intent to reduce the deficit and has been very slow—admittedly for good political reasons—to do so. Investors are disappointed.” In London several years ago most British institutional investors moved out of Canadian currency when resource prices began to decline. Now, said one British bank economist: “What we are seeing is the sum of a lot of small influences, none of which gives rise to a lot of confidence in Canada. Without a doubt, one of those factors is that people in the international market are genuinely disappointed by the lack of resolve of the government.”

But the perception that the federal government has, in the words of one foreign economist, “demonstrated that it doesn’t want to offend too many people” goes beyond the problem of the deficit. Merrill Lynch’s Robinson declared that the traders’ negative feeling toward the Canadian dollar “is due to foot-dragging by the Mulroney government on free trade.” He added: “Mulroney initially proposed it and then there seemed to be a lot of opposition in Ontario and the issue was soft-pedalled. That raised the question of how serious this government is and whether Canada is really ready for a free market.” But even when the Canadian government has taken steps to solve economic problems—by increasing revenues through higher personal taxes—some American economists have been critical. Declared economist Alan Reynolds of Polyconomics, a Morristown, N.J.-based think-tank: “Mulroney’s tax hikes were a good way to weaken Canada’s currency. Capital flows to areas where it draws the greatest after-tax return. Canada’s tax climate is already unattractive, and the direction of policy was unsettling.”

Still, many foreign money market experts pointed out that Canadians themselves have contributed to the dropping value of their dollar by buying U.S. currency or investing in the U.S. economy. Declared John Lipsky, vice-president in the international bond market research office of the New York-based investment firm Salomon Brothers: “To view this as something that foreign investors are doing to the poor Canadian dollar is quite wrong. Canadian markets and Canadian institutions have been uniformly more bearish on their currency than foreigners have.” Added Ian Amstead, an economist with Lloyds Bank PLC in London who specializes in the Canadian, Irish and British economies: “There is not a malicious intent on the part of traders to bring down the value of the Canadian dollar.”

Forces: Economists point out that the Canadian dollar is extremely vulnerable to the international forces at play in the money markets. For one thing, the dollar’s volatility is partly caused by its standing as a “beta,” or satellite currency to the U.S. dollar. As a result, it tends to rise and fall along with the U.S. currency. As well, any movement in the value of the greenback on world markets has an exaggerated swing effect on the Canadian dollar. The dollar is also very vulnerable to speculation. Trading in Canadian currency, by international standards, is considered to be very “thin,” or low-volume. Because of that it is susceptible to shocks, because even a small number of trades can affect the market.

Some experts say that the economy’s performance has little bearing on decisions to buy and sell money. Alberto Giovannini, professor of international finance and economics at Columbia University in New York and an expert on international currency markets, says traders will explain their attitude toward a particular currency by talking about the fundamentals of an economy. But, he added, “really they have no interest in fundamentals. You have to keep in mind one thing: traders have a horizon that is incredibly short. They make and lose money over two or three days at most.”

Many of the decisions about the value of the Canadian currency are made by traders in both London and New York whose knowledge of the country’s economy is principally formed by newspaper reports. Said Richard Cherry, manager of the New York office of the Montreal-based investment firm Levesque Beaubien: “I would guess a lot of the Wall Street financial community gets its information from Canada from a few publications.” In fact, there were a number of traders interviewed by Maclean’s in New York who discussed the Canadian government’s lack of resolve to act on economic problems but who did not know the Prime Minister’s name. Said Giovannini: “This characteristic of the currency markets throws into question whether the fundamental policies of governments, designed to shore up or push down the value of their currencies, have any effect. What really works is for a government to enter the market and try to burn the traders.”

Indeed, others advocated a tougher strategy for Bank of Canada Gov. Gerald Bouey. Some traders said that the present policy of intervening when the value of the Canadian dollar drops by buying it in large amounts—creating a demand for it and sending up its worth—makes the central bank an unwitting accomplice to speculators. Said Reynolds of Polyconomics: “Basically, the Bank of Canada now has to bribe people to stay in Canadian dollars and attract foreigners to buy them with high interest rates.” Fred Allardt, for one, a senior dealer in the foreign currency options division of Donaldson, Lufkin & Jenrette, a New York investment firm which trades between $20 million and $120 million worth of Canadian currency daily, said that among traders “there is generally a lack of confidence in the Bank of Canada.” He added: “It has told people on several occasions that it would back the currency when it hit a certain level—and then when it did, they didn’t do anything. That kind of inaction weakens the currency.”

Danger: The Canadian dollar will likely continue to face the danger of speculation anytime it shows signs of weakness. Explained one New York currency trader: “The Bank of Canada is pretty much fighting a losing war. It cannot raise interest rates much without making unemployment worse. The next couple of weeks will tell you if the Canadian dollar goes to 69 cents or 67 cents. And the thing is that once people start thinking that way about a currency, then the traders will test it. You cannot have foreigners running your currency up and down, though.”

One economist at a British bank in London predicted that the dollar would likely weaken further over the next 12 months and added: “Until a few weeks ago most of the economists in Britain felt it was likely to appreciate. We never held that view.” But Ian Steers, London-based vice-chairman and head of international operations of Wood Gundy of Toronto, told Maclean’s: “My personal view is quite optimistic. I think the Canadian dollar will climb back to 75 cents by the end of the year and that it will gradually move toward par with the U.S. dollar over the next decade.” Whichever way it moves, the dollar will likely continue to be dependent primarily on Canada’s image abroad—even more than on its economic track record. Said Salomon Brothers’ Lipsky: “The Canadian dollar has taken a beating basically on expectations. When will it turn? That involves a change in those expectations. And it remains to be seen what event or policy decision will cause that to happen.”