Canada’s rolling dollar: first crisis after the election
BACKSTAGE IN OTTAWA
Peter C. Newman
Bchind the sudden devaluation of the Canadian dollar is the threat of the worst foreign exchange crisis Canada has faced since 1947. Fixing the dollar on May 2 at a pegged rate of 92'/2 cents averted the immediate danger by halting an unprecedented run on our currency. But it didn’t remove the factors that generated the run. and it is these weak spots in our economic structure that the government will have to repair, and quickly.
What really worries many of the experts who’ve studied the situation is that in other western countries during the postwar period, a currency devaluation has been immediately followed by a heavy influx of investment funds, stabilizing the currency at its new level. But in Canada’s case, at least up to election day, money continued to flow out of Canada, with few signs that the trend wotdd naturally reverse itself.
The first step in restoration of international confidence in our dollar—and that, broadly, is the root of our currency troubles—has to involve some fairly dramatic gesture that will persuade outside investors that our new government intends at least to attempt a reversal of the uninterrupted budget deficits of the last five years. That’s why, no matter what impression was left on the hustings, the government cannot at once launch some popular scheme that involves massive federal expenditures. Instead, it will have to pledge itself to hold down government spending.
Worst threat: rigid controls
The direction Canadian economic development takes during the next decade will depend to a considerable degree on what happens next to our dollar. While no one can predict exactly how' something as intangible as world financial opinion will shift, five main possibilities must be taken into account:
1. That we’ll manage to hold the dollar at its current level, and as our fiscal policies improve the present crisis will pass. This is the official view' of senior advisers at the Finance Department. They believe the 92 Vi -cent rate is appropriate to our economic circumstances, and that if the government follows a sensible fiscal policy, our exchange problem will vanish. The tendency in official Ottaw-a is to regard the May 2 devaluation as more of a warning than a crisis.
2. That the pressure against our dollar wall continue and that we’ll have to call on the International Monetary Fund for help. One of the advantages of pegging our exchange w'ith the IMF is that it will make loans from its reserves to help keep our currency within one percent of the set rate. Canada’s gold and U. S. dollar holdings dropped by $618 million between last October and May 31, leaving our reserves at the lowest level in a decade. If there’s another major run on the Canadian dollar, we’ll be able to bolster our reserves with IMF funds. To lend us the required sums, however, the governors of the IMF would probably demand that Canada improve her own exchange situation by reducing federal budgetary deficits, or. as was the case in Britain recently, by applying official pressure against the upward trend in prices and wages. ‘'The IMF won’t stop Canada living in sin, but it won’t finance it either,” is the way one bond dealer explains it.
3. That the federal government, through the Bank of Canada, will raise interest rates enough to reattract U. S. investment here on a large scale. This would probably mean returning to a fixed and higher bank rate (the minimum charge by the Central Bank on its loans to chartered banks), w'hich in turn would mean a return to “tight" money.
4. That we’ll have to devalue again, probably down to 90 cents. This possibility is being all but ruled out. because it would be only a stopgap measure which in effect would confess our inability to handle the situation.
5. That none of these measures will work, and the federal government will have to introduce a rigid system of foreign exchange controls and import quotas. This would be the most drastic step of all. It would probably mean that Canadians couldn’t holiday
in the U. S. and that only very limited amounts of imported goods would be allowed into the country. At present, no one in Ottawa really believes the crisis will reach such proportions, but W. Farle McLaughlin. president of the Royal Bank of Canada, told his annual meeting in January that a fixed exchange rate would almost inevitably lead to new controls to maintain it. Erie Kierans, president of the Montreal Stock Exchange, has warned that “Canada’s economic independence is threatened by the adoption of a pegged rate for our dollar.”
Devaluation certainly will help to push up the influx of American tourists into Canada this summer. It will also make many of our goods more competitive in world markets, thereby creating some new jobs in the export industries. But at the same time, the move will be reflected in a higher cost of living. The Canadian Importers and Traders Association, for example, has predicted that if we import during 1962 at the same rate as last year, the lower price of our dollar will add about $700 million to the cost of the goods w'e consume.
Price increases have already been announced for imported plastics, foods, textiles, furniture and metals. Some economists predict that the drop in the exchange rate will eventually mean a 2% rise in the cost of living.
While there’s much disagreement over the effects of the devaluation, its causes are less obscure. At least part of the reason the Canadian dollar slipped in value so suddenly at midnight on May 2. was that it had been allowed to remain at an artificially high rate far too long.
The heady days of $1.06
In 1950 the Canadian dollar was set to float according to the international laws of supply and demand. It had previously been pegged at ninety cents, a rate so favorable to foreign speculators that “hot” investment money was coming into the country and snapping up Canadian securities at bargain rates. The
international appetite for Canadian raw materials remained so strong from 1950 to I960 that American investment funds were flowing into the country at a gross rate of three million dollars a day. The resultant demand for Canadian currency pushed the value of our dollar up to $1.06 American.
By the end of the fifties, when the resource boom had calmed down. Ottawa’s “tight money” policies while James Coyne was governor of the Bank of Canada forced many Canadian municipalities, provinces and corporations to go for their financing into the U. S. money market. This maintained the heavy inflow of American currency, and the upward pressure on the Canadian dollar.
While the value of our dollar was kept high. Canada as a trading nation was actually going into debt. In every year since 1956. this country has had an unfavorable balance of payments account (more imports than exports) of over a billion dollars. This precarious situation could last only as long as the inflow of American investment funds continued. When the stream of incoming U. S. dollars began drying up earlier this year, our dollar had to fall.
Foreign investors reduced their flow of money into this country for four main reasons:
^ The general slowdown of our economy, particularly in the investment-hungry resource sector. (The current upturn is expected to last only until November.) ** More lucrative alternate investment opportunities opening up for American business dollars, particularly in the Common Market countries.
^ A general loss of confidence in the stability of investing in Canada. Premier W. A. C. Bennett’s expropriation of B. C. Electric was a big contributor here.
^ A cooling of American investors toward Canada as a result of the Diefenbaker government’s unbroken string of budgetary deficits, its unrealistic attitude toward Britain’s entry into the Common Market, the Coyne episode, and the anti-American measures in Donald Fleming’s baby budget of I960.
The cumulative effect of the sudden halt in the investment-dollar inflow that kept the Canadian dollar too high for too long, plus the conviction among world financial speculators that Canada couldn’t sustain its exchange rate much longer, resulted in a run against our dollar during the last week of April.
The jelly bean issue
The government tried to hold back the monetary avalanche by buying Canadian currency in world money markets, so that the supply-demand situation might balance itself. The money used for this operation came out of the exchange stabilization fund, a reserve of gold and U. S. dollars maintained by the Bank of Canada. During the few days before May 2, the ESF was spending more than fifty million dollars a day in a desperate bid to bolster our dollar.
To stop the flight of capital, the Diefenbaker government was finally forced to peg the Canadian dollar at 921/2. None of the political leaders during the campaign really brought out the deeper significance—or the probable consequences—of the drop in value of our currency. To do so, they would have had to admit that most of the promises they were making would be postponed until the exchange crisis has been licked. “Devaluation,” John Diefenbaker declared, as if frequent enough repetition would make it true, “means increased exports, increased jobs, and more prosperity for Canada.” Lester Pearson, meanwhile, was peppering the Tories with accusations that the devaluation was "a confession of the complete failure of the government’s economic policy.” Throughout their campaign, the Liberals made good use of the issue by distributing phony “Diefendollars” (“the Bunk (sic) of Canada will pay the bearer on demand, more or less, one dollar”), and at a Vancouver rally a liberally minded calypso band put one of devaluation’s effects to music, by singing:
“Dropped the dollar on the federal scene Put up the price of jelly beans.” ^
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