COVER

The dollar in danger

HAL QUINN January 27 1986
COVER

The dollar in danger

HAL QUINN January 27 1986

The dollar in danger

COVER

The verdict was nearly unanimous. Most economists, market analysts and currency traders in the financial capitals of the world agreed last week that it was time to sell Canadian dollars. Many economists criticized the government’s apparent inability to cope with the nation’s deficit. Analysts noted the dual weaknesses of a recent drop in Canada’s trade surplus with the United States and persistently low prices for some of Canada’s major exports. And traders responded quickly to their clients’ demands to sell. As a result, the Canadian dollar plummeted to a record low trading price (70.87 cents U.S.) and a record low price at the close of any trading day (71 cents U.S.). While the Bank of Canada raised its prime lending rate to shore up the currency, prices of imported goods, loans and mortages rose and plans for vacations in the South became less certain.

Slide: The dollar’s slide took place at a time when Prime Minister Brian Mulroney’s government was already under pressure to provide clearer policy directions, and it sparked an immediate uproar in the Commons. Liberal Leader John Turner charged that the dollar’s fall reflected “a recognition on the world markets that there is little good management in the Canadian economy.” Finance Minister Michael Wilson acknowledged that part of the dollar’s weakness reflected concern in the marketplace that the government was “not showing a sufficient degree of resolve in dealing with the federal government deficit.” But he defended the government’s management of the economy and pledged further action on the deficit in his sec-

ond budget, scheduled for next month. At week’s end, he told Maclean ’s: “ I can’t predict where the currency is going and I am not going to predict. But what I would say is that the fundamentals for the most part are very solid as far as Canada is concerned—economic growth, stable inflation, investment intentions and investment performance.” Opposition members said that the government was sending confusing signals to the money traders. On Tuesday Wilson stated that the dollar’s decline was temporary and that it was not the government’s policy to allow interest rates to rise to defend it. He added, “I have never felt that any level in the [Canadian] currency is a benchmark one way or the other that must be protected.” Then, as the dollar fell close to 70 cents U.S., the Bank of Canada announced another interest hike— the fifth in as many weeks. Last Thursday’s 0.17-percentage-point increase fixed the interest rate that the central bank charges on loans to chartered banks at 10.38 per cent, a jump of nearly one per cent from the first of the year. Said Liberal MP Raymond Garneau, a former banker: “The policy of the Bank of Canada is to push the rate of interest ^ up to protect the dollar.

1 But if the minister of fi-

2 nance does not have the Q guts to say so, the signal

is so ambiguous that the marketplace reacts strongly and sells.”

In fact, international traders cited a variety of reasons for selling Canadian dollars. One factor is Canada’s inflation rate, which, at four per cent, is still slightly higher than that of the United States (page 38). But the principal reason is concern over the federal deficit— and the widespread perception that the

federal government is incapable of coping with it. Said Geoffrey Maynard, chief economist for the Chase Manhattan Bank in London: “Canada is still running huge budget deficits which the government is not showing much willingness to deal with. The same is true of the United States, but they can get away with it to a certain extent because of the general health and the size of their economy. Canada cannot.”

Target: In last May’s budget the government reported a deficit of $36.9 billion for 1984-85 and predicted a $33.8billion deficit for 1986. Wilson told Maclean’s that he expects to meet that target, despite the unanticipated payout of $875 million to uninsured depositors because of the failure of two Western Canadian banks. But Michael Manford, chief economist for Merrill Lynch Canada Inc. in Toronto, said that the figures do not take provincial deficits into account. Manford said that if the federal and provincial borrowing needs are combined, “the deficit is well in excess of $40 billion, probably closer to $42 billion.” Indeed, expressed as a percentage of gross national product Canada’s deficit is among the highest of the industrialized nations.

Traders also expressed concern over a dip in Canada’s trade balance. Last week Statistics Canada reported a November drop in Canada’s trade surplus with its chief trading partner, the United States. Exports there fell 5.3 per cent from October, while the value of

U.S. imports rose 11.5 per cent. The result: Canada’s surplus in trade with the United States dropped to $1.15 billion from $3.2 billion. As well, the overall trade surplus with the United States in the first 11 months of 1985 was offset by mounting trade deficits with Japan and Western Europe.

According to Maynard, there is also a general feeling that Canada’s trade performance will deteriorate over the next year or so, putting further downward pressure on the dollar. He added: “The economy is expected to grow by only 2.5 to three per cent in 1986, and this will probably lead to more imports. At the same time, the market looks weak for commodities. Put those factors together and you have a steadily worsening trade balance.”

But other experts said the Canadian dollar was taking an unfair beating in the international markets. Thomas D’Aquino, president of the Ottawabased Business Council on National Issues, said, “If you look at all the critical growth figures and compare them to other industrialized economies, we are looking exceptionally good” (page 34). For his part, Wilson told Maclean’s that “imports are up because there is more basic strength in our domestic economy.” As for the deficit, D’Aquino pointed out that the problem “didn’t emerge yesterday.” He added,“For some of these people to say concern

about our debt is causing the decline in the dollar is really an exaggeration— and it’s one that is feeding on itself.” Added John Lipsky, vice-president in the international bond market research office of Salomon Brothers in New York: “All of the reasons cited for the fall of the Canadian dollar are prospective arguments, not current ones. So the weakness of the Canadian dollar is largely based on expectations—including the expectation that the U.S. dollar will continue to fall.”

Nervous: Indeed, concern over the future course of the U.S. economy—and of U.S. interest rates—added to the nervousness on world financial markets last week. Investors, just recovering from the record drop on the New York Stock Exchange on Jan. 8, sought a traditional safe haven—gold. In Europe the price of the precious metal reached a 19-month high of $377, fuelled in part by uncertainty over continuing U.S.Libyan tension. And investors and market analysts anxiously awaited the outcome of a meeting of finance ministers and central bankers of the Group of Five (G5)—Britain, France, West Germany, Japan and the United States—in London at week’s end. Economists predicted that the G5 members would agree to hold the U.S. dollar down and attempt to lower interest rates.

Any agreement to lower U.S. interest rates will probably reduce pressure on

the Bank of Canada to maintain high rates. And Wilson said that he is eager to use next month’s budget to answer criticism that the nation’s economy is being mismanaged. He told Maclean’s that the government’s first budget was partly responsible for the apparent international consensus that the government lacks the resolve to deal with the deficit. Said Wilson: “There is a perception that because the government backed away from the old-age security proposal [to deindex pensions], we’ve backed away from everything. But we intend to bring in a budget that will lower the deficit further next year.” Many experts say that with such a demonstration of resolve, Wilson and the Conservative government might increase their credibility abroad. Said D’Aquino: “This is the government’s last opportunity in its first mandate to make a substantial difference on the deficit. If it misses this opportunity, I think it will be costly politically, not just in terms of business support but also in terms of jobs and confidence. If they grab the opportunity, I think it could really pay off.” But the challenge to the government will be to accomplish its objectives abroad without a major loss of support at home.

-HAL QUINN in

MICHAEL ROSE

ALISON HARE

and LENNY

LENNY GLYNN