Buisiness

The dollar takes a dive

JOHN GEDDES February 2 1998
Buisiness

The dollar takes a dive

JOHN GEDDES February 2 1998

The dollar takes a dive

Buisiness

Turmoil in Asia helps push the loonie to its lowest point ever

JOHN GEDDES

It started with queasiness in the B.C. lumber industry, then spread to Bay Street as a currency illness that showed signs of lingering like a nagging winter cold. The Asian flu—that exotic virus blamed for sapping the strength of much of the world’s economy—has struck Canada with an unsettling array of symptoms. Last week, Vancouverbased forestry giant MacMillan Bloedel Ltd. announced plans to cut its workforce by onefifth, eliminating 2,700 jobs, largely because of a collapse in lumber sales to Japan. On the same day, the malaise in Asian commodities markets pushed the Canadian dollar to its lowest level ever. And this was no 24-hour bug: the dollar dipped even further later in the week after the Bank of Canada failed to prop up the sagging loonie with higher interest rates. “What’s happening is the growing recognition that the bloom is coming off the Canadian economy,” warned Bank of Nova Scotia deputy chief economist Aron Gampel.

‘We are, to a large extent, succumbing to the Asian flu that is sweeping the globe.”

Succumbing, perhaps, but not so sick that economists are trashing their projections for a decent performance by the Canadian economy in 1998. With consumer spending in good shape and interest rates near 30-year lows, most analysts still expect growth in the three-per-cent range this year, down only slightly from their predictions last fall. And if the Canadian dollar’s unprecedented dive to 68.81 cents (U-S.) sent shivers through financial markets, the chill was partially offset by the report that Canada posted a better-thanexpected trade surplus in November of more than $1.03 billion. ‘We don’t have a currency crisis in Canada right now,” concluded Paul Summerville, chief economist at the investment house RBC Dominion Securities. ‘We have an incident.”

In fact, the Canadian dollar was pummelled last week after the Bank of Canada woke up currency traders with two key statements. The governor of the bank, Gordon Thiessen, conceded in a speech in Kitchener, Ont., that the Asian crisis would hurt Canadian growth this year. The next day in Montreal, Thiessen’s senior deputy, Bernard Bonin, suggested to reporters that the bank would not bump up interest rates to bolster the Canadian dollar.

The two points are closely connected: to counter those weaker overseas markets for Canadian exports, the bank sees a need for low rates at home to stimulate domestic spending. Lower rates, however, mean there is less demand for Canadian dollars from foreign investors. In other words, the dollar’s fall was no mystery. “There hasn’t been a breakdown in confidence in the Canadian dollar,” Summerville said. ‘There has been a natural adjustment because of the fall in commodity prices resulting from what’s going on in Asia.”

Not everyone shares that sanguine view of the dollar’s dive. Some observers feared that without an aggressive defence from Thiessen, the Canadian dollar might end up being lumped in with the currencies of other resource-oriented economies, including Australia and South Africa, that have been hit even harder by the Asian contagion. “I think it is very dangerous, frankly, for the central bank to give the impression that it is unconcerned about the value of the domestic currency,” said Sherry Cooper, chief economist of the brokerage firm Nesbitt Burns Inc. “In a time of extreme turmoil, you need a strong central bank.” A swift rate hike—or even some tough talk from Thiessen and his deputy last week—might have been enough to calm currency traders, she argued. Instead, markets were left with the impression that the Bank of Canada is content to watch the Canadian dollar drift still lower in the weeks ahead.

The response of exporters: go right ahead. A lower dollar makes their products more competitive in the crucial U.S. market. (The other side of this old tug of war between economic interests is the impact on consumers, who will face higher prices for U.S. imports and for winter vacations.) The benefits for exporters, however, are limited in this case because the loonie has held its own recently against most other currencies. Craig Neeser, senior vice-president of MacMillan Bloedel’s solid-wood-products business, glumly noted that the Canadian dollar has actually appreciated against Japan’s unsteady yen. That rules out any currency-based price cut for the fourby-fours that MacBlo supplies to the Japanese construction industry. And the company could use a break in Japan, destination of some $500 million worth of its $1.2 billion in wood-product sales last year. That vital market has “collapsed,” Neeser said, as housing starts in Japan trend sharply lower for the second straight year.

Compared with its smaller neighbors, Japan’s economy looks solid. Beginning last summer with the crash of Thailand’s financial markets, and followed by severe currency shocks in several other Southeast Asian countries, the spreading crisis has exposed the vulnerability of the region’s overextended banks and overpriced real estate. Still, less than 10 per cent of Canada’s trade is with Asia, including Japan. Why should the region’s woes matter much here? Thiessen tried to answer that question last week in his speech, concluding that the indirect impact of the crisis on world prices is more worrisome for Canada than any direct decline in exports shipped across the Pacific. A scan of recent commodity prices leaves little doubt that Thiessen is right. Lumber, copper and crude oil prices are all deep in the doldrums, in each case at least partly because of reduced Asian demand. But the commodities outlook is not unremittingly bleak. The price of newsprint, a leading Canadian export, has held up, mainly on the strength of U.S. and European demand. So has the price of aluminum, another key Canadian product.

As the Asian flu strains the immune system of Canada’s naturalresource sector, some observers see an even bigger test under way.

Summerville said this is the first real challenge faced by the new economic order that Canada has entered by fits and starts over the past decade. That overhaul came in three stages: the vanquishing of inflation under then-Bank of Canada governor John Crow in the late 1980s; the restructuring of industries struggling to stay competitive under the Tory-negotiated free trade deals in the same era; and the successful drive to eliminate the federal deficit, launched by Finance Minister Paul Martin in 1995. Without those painful changes, Summerville argues, the Canadian dollar—and economy—would now be staggering. Instead, Canada is holding up well, all things considered. “There has been a dramatic, unexpected change in the terms of trade,” Summerville said. “No one expected one-third of the world’s economy in Asia to fall off a cliff.”

The battering of the dollar comes at a crucial time in the drafting of the 1998 federal budget, expected in late February. Martin is under pressure to spend the so-called fiscal dividend—the extra money that will be available after he balances Ottawa’s books—on new programs or tax cuts. Those urging him to concentrate instead on paying down the nearly $600-billion federal debt argue that the recent sell-off of the Canadian currency bolsters their case. In a crisis, they say, investors have shown a propensity to flee Canada for the United States. Shrinking the debt would make Canada a more secure haven when the global economy shudders. “Hopefully this will underline the importance of getting Canada’s debt down,” Summerville said.

Recent history suggests that Summerville and other debt hawks may get their wish. A case of financial market jitters that hit Canada after Mexico’s “peso crisis” in late 1994 helped Martin make the case for his landmark deficit-slashing 1995 budget. Again this year, distant economic tremors may influence his prescription for strong medicine in the Canadian economy. □