THE GREAT MONEY PANIC OF 1963

A re-creation of the events in Washington that set of—and then halted — a wild flight away from the Canadian dollar

PETER C. NEWMAN May 16 1964

THE GREAT MONEY PANIC OF 1963

A re-creation of the events in Washington that set of—and then halted — a wild flight away from the Canadian dollar

PETER C. NEWMAN May 16 1964

THE GREAT MONEY PANIC OF 1963

A re-creation of the events in Washington that set of—and then halted — a wild flight away from the Canadian dollar

PETER C. NEWMAN

The great money panic of 1963 began and ended so abruptly that many Canadians are only vaguely aware that it happened at all, and only a handful of men in Ottawa and Washington are fully aware of how it happened, or why. From these men, and from the documents in the case, I have reconstructed the leading events of what may well have been the most critical four days in our economic history: four days

during which our money markets degenerated from fear to panic and it seemed possible that anarchy might overtake Canada’s financial system. This is the story of the miscalculation that brought the panic on, the half-measure that called it off, and the warning it leaves behind.

The story begins at a few minutes after ten on the morning of July 18, 1963. Francis Linville, counselor for economic affairs in the U. S. Embassy in Ottawa, rings the office of Finance Minister Walter Gordon. Linville requests an immediate interview for Merlyn Trued, head of the international finance section of the U. S. treasury, who has flown up unannounced from Washington with news of an “urgent development.”

Gordon's list of appointments for

the day is already filled by people whose purpose is to assault his recent budget, brought down thirty-five days before and still being amended clause by clause. He also has a noon appointment with James Rockefeller, head of the First National City Bank of New York, who wants to test the Canadian government’s reaction to his purchase of a majority interest in the Dutch-owned Mercantile Bank of Canada. Gordon intends to lunch late, and since this is the only time he has free, he invites Trued and Linville to meet him at the Rideau Club. He also invites his own deputy minister, Bob Bryce, one of his assistant deputy ministers, Wynne Plumptre, and the senior deputy governor of the Bank of Canada, Bob Beattie.

At lunch in the Rideau Club dining room. Trued briefs the Canadians on the contents of a special message

President Kennedy has sent to Congress that morning. What the president has asked for, Trued says, is an “interest-equalization tax” in the form of a fifteen percent levy on the purchase by Americans of foreign longterm bond issues and new stock issues. The reasoning behind the Kennedy proposal is something like this:

1) For several years the U. S. has been sending dollars out of the country at a far faster rate than it has been taking foreign currencies in. The resulting balance-of-payments deficit has reached the critical stage — in 1963 the U. S. is going into the red at the rate of three billion dollars a year.

2) A major cause is foreign borrowing in the U. S., which now accounts for half the total deficit. What attracts the foreign borrowers to the U. S., of course, is relatively cheap money: by and large, U. S. interest

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The Kennedy tax was, in Walter Gordon’s words, "a real crisis.” Could it be dealt with in time?

rates are at least one percent lower than rates in most other markets, including Canada.

3) But if American buyers of foreign securities faced a fifteen percent tax on their transactions, they would have to charge the foreign borrowers an annual interest rate approximately one percent higher in order to get their money back in the long run. This is the background of the phrase “interest-equalization tax“; for foreigners it would make interest rates in the U. S. money-market equal to rates in most other markets.

Of course. Trued concludes, what the president really wants is not to collect the tax but to encourage foreign borrowers to do their borrowing at home. Presumably many of them would, if the price advantage of dealing in the U. S. were to disappear.

While the six men are still at lunch in Ottawa, the secretary of the treasury, Douglas Dillon, tells a group of reporters in Washington that although the new measure applies to twentytwo nations, he expects Canada to be affected most severely. He points out that in the preceding six months Canada has sold new securities in the U. S. worth $607 million — sixty-seven percent of all the foreign issues taken up during that time. (Nearly half of the amount was the Quebec hydro loan to finance the cost of nationalizing the province’s electricity-producing firms, although the actual amount of the loan was drawn down over the following fifteen months.)

While Parliament hedges, stocks plunge

The full implications of Trued’s briefing arc not yet clear to the Canadian officials as the Rideau Club lunch breaks up and Gordon rushes across Wellington Street to announce the Kennedy measure to the Commons. He concedes that it might have an important effect on Canada but adds that it would be unwise to comment fully until there has been time to study the proposals in depth. George Nowlan, the Tory financial critic, calls the announcement “one of the most important statements which could have been made to the Parliament of Canada at any time in the immediate past, present or future,” but cautiously refrains from judging its potential effects.

The first concrete reaction to the Kennedy “interest - equalization” proposals comes from the shrewd floor traders on the Toronto Stock Exchange, who have already learned the news over the Dow-Jones ticker tape. Between noon and one o'clock a selling wave hits the market, driving the industrial index down 8.36 points. The tumble is due to the market's fear that the tax will drive American investors out of Canadian stock purchases. The traders are also afraid that to escape the tax American investors might dispose of their Canadian holdings at sacrifice prices. Stocks plummet through the day.

Walter Gordon spends the afternoon in the Commons in futile defense of his disappearing budget. He has now received several memos from his officials about the potential impact of the new Kennedy tax. He is deeply disturbed. When he returns to his office — which is still beleaguered by delegations protesting his budget measures — he says to Brian Land, his executive assistant, “This time we've got a real crisis on our hands.” Later in the evening, External Af-

fairs Secretary Paul Martin calls on W. Walton Butterworth, the U. S. ambassador, and in an unusual session pleads Canada's case against the proposed tax. Louis Rasminskv, the Bank of Canada governor, is out of town on a fishing holiday. He is reached by telephone and asked to return to Ottawa as soon as he possibly can.

Ón Friday, July 19, Canada's financial community moves to the edge of panic. During the first hours of

trading on the Toronto Stock Exchange, the stampede to sell pushes the industrial index down 15.17 points. This is the biggest one-hour plunge in the market's recorded history', including the crash of 1929. At the same time, the combination of Gordon's nationalistic budget and the Kennedy measure has so frightened the financial managers of some American subsidiaries in Canada that they hurriedly begin sending to the U. S. not just all current dividends that can

be moved out, but some accumulated cash reserves as well.

Much of the panic is based on the conviction of the Canadian business community that a jump in Canadian interest rates will be required to reattract American investment here over the barrier of the new tax. They feel that higher interest rates may bring with ’them foreign-exchange controls and possibly a further devaluation of the Canadian dollar. This fear gains both legitimacy and momentum when Eric Kicrans (then president of the Montreal Stock Exchange) declares that, given the American action, “the wisdom of maintaining a fixed exchange rate has become questionable.”

As investors begin to hedge against the possibility of devaluation by buying U. S. currency, the selloff of Canadian dollars accelerates to an unprecedented level. Between Thursday noon and Friday evening, Canada's foreign-exchange reserves are depleted by $1 10 millions — a run of such proportions that it surpasses even the drain on the exchange fund of any two days during the 1962 devaluation crisis. By Friday evening, Bank of Canada agents across the country report to Ottawa that unless something is done, there will be an even bigger outflow on Monday.

The Government becomes determined that Canada must somehow win an exemption from the Kennedy proposals over the weekend.

A council of desperation is called for Saturday morning in Walter Gordon’s office in the Confederation Building on Wellington Street. Charles Ritchie, Canada’s ambassador in Washington, is asked to arrange, as tactfully as possible, that senior offi-

cials of the U. S. treasury remain on call during the weekend. An emergency flight to Washington is booked on a department of transport Viscount.

The meeting in Gordon’s office — attended by Rasminsky, Bryce, Plumptre and Beattie, as well as Gordon Robertson, the clerk of the privy council, and Ed Ritchie, the assistant undersecretary of state, who specializes in American-Canadian economic relations — works out the approach to be taken in Washington. Rasminsky, Plumptre and Ritchie leave for the airport and the waiting plane.

The confrontation takes place later that afternoon in the Treasury Building office of Secretary Douglas Dillon. He is flanked by George Ball, U. S. undersecretary of state, Robert Roosa, undersecretary of the treasury for monetary affairs, and Stan Surrey, an assistant secretary of the treasury for legal affairs.

The sky is overcast by an eclipse of the sun and as the eight men debate the economic prospects of Canada, unnatural shadows skip on the White House lawn across the street. The meetings break up to be reconvened next day. Throughout Sunday one or other of the Canadians reports progress to Gordon over an open long-distance line in Dillon’s outer office.

The case for Canada is put forward mainly by Rasminsky, a convincing spokesman since the Canadian banker has an impressive international reputation gained as executive director of the Washington-based International Monetary Fund and the International Bank for Reconstruction and Development. With the ruminative manner of a professor sharing discoveries at

a seminar of graduate economics students, the Bank of Canada governor presents his arguments. The treasury experts who worked on the stock-tax measure, he says, haven't stopped to calculate the effect it might have on transactions with each of the nations concerned. Canada's trade deficit with the U. S. has for many years more than balanced the sale of Canadian securities to Americans; this country therefore helps strengthen, father than deteriorate, the U. S. balance of payments. Between 1951 and 1961, despite capital inflows from the U. S. of $7.3 billion, our balance of payments with the U. S. wound up with a six-bil 1 ion-dollar deficit. Any discouragement of Canadian borrowing in the U. S. might cause an even larger deficit in our accounts with the U. S., requiring Canada to apply curbs on American imports. And at this point the Americans might begin to lose some of those helpful Canadian billions, making their own problem worse.

The American officials are impressed by the weight of Rasminsky’s case and are slightly shamefaced that their own bureaucrats hadn't realized the bill as it stood could do the U. S. more harm than good. They agree to grant Canada an exemption. ("The inclusion of Canada," Merfyn Trued, the original messenger to Ottawa, admitted later, “probably means that our staff work wasn’t too good. It turned out that the existing integration of the capital markets of the two countries was much greater than we'd expected. It was a great surprise.")

By mid-afternoon on Sunday, Dillon and Gordon have worked out a joint communique by telephone. In Ottawa, Walter Gordon asks Bob Bryce, his deputy minister, to have it mimeographed. Tom Kent, the prime minister's policy adviser, who has been keeping Lester Pearson in touch with the negotiations, orders a press conference set up to announce the news before the opening of Monday’s markets.

On paper, the American concession turns out to be a half-measure; while it does make Canada the only exception among the twenty-two countries affected by the Kennedy proposal, the law itself is not changed. The president is simply authorized to “modify the application of the tax by the establishment from time to time of exemptions'' which will “permit tax-free purchase of new issues needed to maintain the unimpeded flow of trade and payments between the two countries.” This is interpreted to mean that the president will allow Canadian borrowing on the New York money market to remain at its historic level (between three hundred million and four hundred million dollars a year) — though the actual amount remains at the president's discretion. In return, Canada undertakes not to attempt to build up its exchange reserves by using the American exemption.

On Monday morning, the Toronto Stock Exchange industrial index climbs back eight points in the first hour of trading and the expected exodus of Canadian dollars fails to materialize. The crisis has ended; now only its implications remain to be studied.

By April, nine months later, the “interest-equalization tax” still hadn't been enacted. It had passed the U. S. House of Representatives but was being stalled in the Senate by the civilrights filibuster.

Superficially, Canada has been little affected by the events of last July. The fact that we managed to win a reversal of the American policy proved that we're far from defenseless, but the situation could be deceptive. By one of those happy coincidences which

have distinguished our economic history. the windfall of the half-bill iondollar wheat purchase by Russia has so boosted our balance-ot'-payments position that the troubles we might yet encounter as a result of the Kennedy tax are not pressing us for the time being.

During a Commons question period last summer, Opposition Leader John Diefenbaker thundered that as a result of the events of July 18-21, the U. S. “now has a veto with regard to

the expansion of Canada’s economy, which is something not in keeping with the sovereignty of this nation.” The Tory leader wasn't exaggerating, although neither he nor anyone else has suggested what to do about it. The form of the Canadian exemption from the projected tax means that when it's passed, our access to U. S. capital will be subject to the decisions of the American president, rather than the impersonal forces of the money markets. ★