BUSINESS

THE SOARING U.S. DOLLAR

THE AMERICAN CURRENCY CLIMBS AGAINST THE CANADIAN DOLLAR AS THE U.S. TRADE DEFICIT FALLS

TOM FENNELL June 5 1989
BUSINESS

THE SOARING U.S. DOLLAR

THE AMERICAN CURRENCY CLIMBS AGAINST THE CANADIAN DOLLAR AS THE U.S. TRADE DEFICIT FALLS

TOM FENNELL June 5 1989

THE SOARING U.S. DOLLAR

BUSINESS

THE AMERICAN CURRENCY CLIMBS AGAINST THE CANADIAN DOLLAR AS THE U.S. TRADE DEFICIT FALLS

Last summer, propelled by a sudden burst of confidence among international currency traders in Canada’s thenrobust economy, the dollar soared in June to a 6½-year high of 83.19 cents in terms of U.S. currency. And just three months ago, in February, it set a six-year record at 84.30 U.S. cents. But on May 24, the dollar plunged just over three-quarters of an American cent to 82.60 cents at one point, before recovering most of the ground at week’s end to close at 83.24. The drop was attributed partly to rumors that Finance Minister Michael Wilson might be forced to resign after it was revealed that he had known that highlights of his April 26 annual budget had been leaked in advance to Mutual Life Assurance Co. of Canada. Said Steven Stinson, a Montrealbased economist with the Royal Bank of Canada: “When the finance minister is in trouble, the government loses credibility, and investors are worried that it will backtrack on its fiscal policy.”

But the main force pushing the Canadian dollar down was a sudden surge in the value of the U.S. dollar on world currency exchanges. That took place despite efforts by the world’s leading industrialized countries during the past four years to reduce the value of the U.S. dollar

in relation to other currencies. In September,

1985, the so-called G-5 partners—the United States, Japan, West Germany, Britain and France—signed the Plaza Accord in New York City. Under that agreement, which Canada and Italy endorsed eight months later at the G-7 summit in Tokyo, the governments agreed to have their central banks sell U.S. dollars and buy weaker currencies. By doing so, the seven sought to drive down the value of the American dollar. That was designed in turn to make American exports cheaper—and correct the yawning, and politically explosive, U.S. foreign trade deficit in the process. The trade deficit— the gap between what the country earns from exports and spends on imports—had grown so wide that many U.S. politicians began to campaign for trade sanctions against some of the G7 countries, including Canada. Now, some international money-traders say that the surge in the value of the U.S. dollar reveals confusion, if not discord, in the G-7, while others suggested that the U.S. currency is merely reflecting a strong U.S. economy and a declining trade imbalance. And some analysts warned that the U.S. dollar could still climb even higher against its Canadian counterpart.

The U.S. trade deficit, which fell to $165 billion at the end of 1988 from $204 billion in

1986, has come down as America’s manufactured goods became cheaper abroad. And for the most part, over the past year and a half the central banks have succeeded in keeping the U.S. dollar stable. But over the past three months, the American currency started to climb against its major competitors: the West German mark and Japanese yen. That confused many money-traders and frustrated the G-7’s central bankers, who had been predicting that

the U.S. dollar would drift downward in 1989. In fact, on May 22 it reached a 29-month high against the mark and the yen, before closing at week’s end at about 2 marks and 142 yen.

Last week, in an attempt to slow the U.S. dollar’s climb, the central banks of all the major industrialized nations—including the Bank of Canada—stepped up their sales of U.S. currency on the open market. By doing so they sought to flood the market with American money and dampen its value. By week’s end, they had slowed the rise—at least temporarily. But most analysts say that it is almost impossible for the central banks to completely reverse the market solely by dumping their U.S. dollar reserves. Renato Strauss, a currency trader specializing in Japanese yen in the New York City office of Zurich-based Bank Julius Baer & Co., told Maclean’s that Bank of Japan may have sold almost $2.5 billion in U.S. currency on the open market on May 22 alone, but the

action had little effect. Said Strauss: “Obviously, they have not been successful.”

The climb in the value of the U.S. dollar also defied many analysts’ predictions. According to most year-end economic forecasts, the dollar was supposed to drift downward. Those predictions were based on continuing high U.S. trade deficits and a weaker American economy. Instead, higher interest rates imposed by U.S. Federal Reserve Board chairman Alan Greenspan in his battle to contain U.S. inflation made it more profitable for investors to shift savings

into American-dollar accounts, stocks and bonds—increasing demand for dollars. As well, political instability in Japan and West Germany encouraged the flow of funds into U.S. investments. Japan’s ruling Liberal Democrats have been rocked by a stock-trading scandal that led to the resignation of Prime Minister Noboru Takeshita. Meanwhile, West German Chancellor Helmut Kohl, whose Christian Democratic Party has recently lost two key local elections, is facing a general election within a year. And analysts say that because of their political problems, neither Japanese nor German leaders will risk consumer anger by raising interest rates and thereby attracting investments for the resulting higher returns.

The rise of the U.S. dollar may also reflect confidence in the apparent soundness of the U.S. economy. Douglas Peters, chief economist with the Toronto-Dominion Bank, argued that investors have simply decided that the U.S. dollar was undervalued and are buying the currency again. That new confidence is based in part on an improvement in the U.S. trade performance. In March, the latest month for which figures are available, the American foreign trade deficit declined to $10.5 billion, down more than $1 billion in a single month and well below the peak of $19.5 billion for the single month of October, 1987. Said Peters: “I think the U.S. dollar will maintain its present level, and maybe even strengthen.”

That strength has a negative impact on the Canadian dollar. As well, demand for Canadian currency has been dampened further by the controversy surrounding Wilson and the budget leak. After the Canadian dollar’s drop last week, currency dealers said that the Bank of Canada intervened heavily in exchange markets to shore up its value. At the same time, the central 3 bank maintained its policy of keeping interest rates high— &lt its own trend-setting rate ° rose slightly to 12.4 per cent from 12.3 per cent the previous week—in another signal that Ottawa is determined to protect the dollar’s exchange value. Despite the dollar’s buffeting, said Bert Squires, a senior currency trader at the Royal Bank, “compared to some other currencies, our dollar is still doing well.” But as the U.S. trade deficit drops and the American dollar gathers strength, it may well become more difficult to maintain that performance.

TOM FENNELL

PAUL KAIHLA

Toronto