BUSINESS

PEAKS AND VALLEYS

A panic in financial markets subsides but only after interest rates soar to new heights

JOHN DALY April 18 1994
BUSINESS

PEAKS AND VALLEYS

A panic in financial markets subsides but only after interest rates soar to new heights

JOHN DALY April 18 1994

PEAKS AND VALLEYS

BUSINESS

A panic in financial markets subsides but only after interest rates soar to new heights

JOHN DALY

For traders on Bay Street last week, financial markets may have settled down after two weeks of turmoil. But across the rest of the country, the impact of rapidly rising interest rates and dramatic swings in the value of the Canadian dollar has continued to ripple through the economy. Like thousands of other Prairie grain producers, 43year-old Doug Faller, who owns a 960-acre farm 50 km north of Regina, questioned why Bank of Canada governor Gordon Thiessen has pushed rates up so high in an effort to defend the value of the dollar on international currency markets. For Faller, a low dollar is a plus—about 80 per cent of his crop is bound for export, and each drop in the dollar reduces the price that foreign buyers have to pay for his grain in their currency. High interest rates, by contrast, increase his costs. Faller renewed the mortgage on his farm in March at 7% per cent— beating the most recent round of rate hikes. But he also has a floating rate loan on a new seeding and cultivating machine, worth more than $40,000. Faller said that he hopes Thiessen, who grew up in rural Saskatchewan, will remember his roots when considering the Bank’s next moves. “I don’t know how we rank in the pecking

order as far as monetary and fiscal policy goes,” Faller said. “I suspect not too high.” Indeed, for the past three weeks, Thiessen has been more concerned with soothing the frayed nerves of powerful financiers at home and abroad, than with easing the interest rate burden on farmers, small business owners and home buyers. Speaking to an audience of several hundred business executives at Toronto’s Royal York Hotel last week, Thiessen said that the Bank’s overriding goal is still to “seek to preserve the value of the money we use in Canada from being eroded by inflation.” To demonstrate that resolve, the Bank raised its trendsetting rate again last week, by 0.57 percentage points to 6.21 per cent, up almost two percentage points since March 22. Thiessen argued that the economy is fundamentally strong and that inflation is low, which means that the jitters in financial markets should be temporary. “We’ve had these bouts of turbulence before and we’ve gotten through them,” Thiessen said. “I hope the fundamentals will show through.”

Two days later, some of those fundamentals did, in fact, appear: Statistics Canada reported that the unemployment rate declined by 0.5 percentage points in March to

10.6 per cent. Still, Thiessen declined to speculate about how long the current high interest rates will last. And at week’s end, the credit rating agency, Moody’s Investors Service Inc. of New York City, put the bonds issued by Canada in foreign currencies on notice for a possible downgrade. Moody’s stated that “the usual beneficial effects of an economic upturn on public sector finances will be less robust than usual.”

The markets themselves reacted more decisively. Both the dollar and the Toronto Stock Exchange steadied after plunging steadily for almost two weeks. The TSE 300 Composite Index closed at 4327.4 points, down just 2.2 points for the week. The dollar stabilized as well, closing at 72.28 cents, the same level as at the close of trading the previous week. However, at the end of last week, ordinary Canadians were still stuck with high rates for loans and mortgages. And although Thiessen appears to be more approachable and down-to-earth than his predecessor, the severe and austere John Crow, he politely declined to offer any specific advice to consumers or home buyers on what they should do about the high rates. “Anything I might say might be taken as some sort of policy,”

Thiessen told reporters after his speech. “Even my mother has difficulty with me when I try to explain to her why she is getting less on her savings than she used to.”

Thiessen also carefully avoided criticizing Finance Minister Paul Martin. Opposition politicians and many economists say that international investors are alarmed by both

a year boosts the industry’s revenues by an estimated $130 million. “As long as the Canadian dollar is weakening, it makes our job easier,” said Gerald Friesen, vice-president of finance for International Forest Products Ltd. of Vancouver.

But like many other executives in the forest industry and other export-dependent sectors, Friesen says that both interest rates and the dollar are unlikely to decline any further.

THE DOLLAR’S WILD RIDE

Ottawa and the provinces’ high debt loads, and that Martin and his provincial counterparts must do more to slash their budget deficits. .Thiessen appears to share at least I some of those concerns. “Deficits I that continually add to the debt so j that the ratio of the debt to the size 1 of the economy continues to rise are not sustainable over time,” Thiessen said. By that measure, Martin is falling behind. Statistics Canada reported last week that Ottawa’s total debt reached $506 billion at the end of March, the equivalent of 73 per cent of the nation’s gross domestic product. Martin’s budget forecasts that that ratio will rise to 75 per cent over the next two years.

But last week Martin rejected calls that he should bring down a new budget with more drastic spending cuts. Speaking to reporters in Montreal, Martin also insisted that his deficit projection of $39.7 billion for the 19941995 fiscal year, which began on April 1, still stands, despite recent jumps in interest rates that will force the government to pay more to borrow money. “There is sufficient room to manoeuvre in our budget,” Martin said.

Outside of Ottawa and the offices of Bay Street brokerage firms, however, many business executives—particularly those who depend on exports—fear the Bank of Canada’s sudden rate increases could put a damper on the recovery. Within British Columbia’s forest industry, which exports more than three-quarters of its production to the United States and Asia, many executives have cheered over the past three years as the dollar has declined steadily from a peak of 88.6 cents (U.S.) in 1991. A one-cent decline in the value of the dollar that lasts for

“What we have now is a bonus,” said Friesen. “But my sense is that the pendulum has swung through.” Still, even if the Bank of Canada pushes the dollar higher, Friesen says that his industry would be able to cope if it settled in the 75 to 80 cent (U.S.) range. In the meantime, Friesen, like many exporters, is attempting to minimize the impact of the dollar’s short-term fluctuations by dealing in the currency futures market.

Basically, that allows him to arrange for deliveries of specialty cut lumber to foreign customers two months in advance at an exchange rate set now. Friesen said the use of futures is common in transactions with Asian customers. But in recent weeks, Martin: ‘room

the volatility of the dollar has -

caused him to make similar arrangements with U.S. customers.

In the Alberta oil patch, the dollar’s decline has helped producers recoup at least some of the revenues that they have lost because of falling world petroleum prices. Oil prices on international markets, which are set in U.S. dollars, have fallen by roughly $3 a barrel to $15.57 (U.S.) since last summer. The dollar has fallen by almost six cents over the same period. According to Bob Feick, a vicepresident of the Calgary-based Canadian Association of Petroleum Producers, each one-cent decline in the value of the Canadian dollar adds about 25 cents a barrel to the revenues of Canadian producers, so they have received a boost worth roughly $1.50 a barrel.

But although a weak dollar helps exporters, Thiessen has other factors that he has to consider when setting interest rates. William Robson, an economist with the C. D. Howe Institute in Toronto, says that the recent slide in the dollar reflects international investors’ concerns about Ottawa and the provinces’ ability to repay their debts. “It’s the leading edge of a foreign debt crisis,” said Robson. He argues that the Bank of Canada simply cannot set interest rates at an artificially low level. He says that investors are already demanding that Ottawa and the provinces pay a higher rate of interest than other countries because of the growing risk associated with their debt loads. If investors believe that the Bank of Canada may be willing to tolerate higher levels of inflation, it would add another element of risk to the loans—the risk that they would be repaid in deflated dollars. As a result, lenders would demand even higher interest rates.

However, other economists challenge the assertion that government debts and deficits cause high interest rates. In an article to be published in Canadian Business Economics this week, Toronto economist Peter Spiro compares U.S. and Canadian interest rates over the past 15 years and budget deficits in the two countries. He found that Canadian rates actually moved closer to U.S. rates during periods when Ottawa’s deficit was growing faster than the U.S. federal deficit.

Spiro also disputes Thiessen’s declaration that lowering the inflation rate will inevitably bring about lower interest rates. To wrestle down inflation, Crow and Thiessen have kept Canada’s real interest rate—the gap between interest rates and the infla^ tion rate—at historically g high levels. Spiro says that S international statistical evis dence shows that “lower inflation is associated with permanently higher real

to manoeuvre’

interest rates.” In part, Spiro says that is because investors doubt that extremely low inflation can be sustained.

For business owners, home buyers and farmers like Doug Faller, who were just finding their feet after a punishing recession, that prospect is the one they fear. “There is a real world, after all,” said Fallen “I’m no economist, but I don’t see the fundamental demand for capital that justifies these interest rates.” But with both the dollar and financial markets on the rise again at the end of last week, many analysts were saying that Thiessen now has a chance to grant Faller—and millions of other Canadians—a little relief.

JOHN DALY