The plummeting dollar
When banks in the United States, led by the First National Bank of Chicago, began to ratchet up interest rates last week, the outlook for the fragile Canadian dollar darkened rapidly. Throughout the vast telephoneand computer-linked network that forms the world’s money market, reports that U.S. prime interest rates were climbing by half a percentage point produced a swift reaction. Money traders at the influential Chicago Mercantile Exchange and other key financial markets quickly drove up the U.S. dollar’s value at the expense of almost every other major Western currency. Then the Bank of Canada raised its trend-setting interest rate to 12.36 per cent from 11.98 per cent in an attempt to prevent another flight of Canadian funds to U.S. greenbacks. The effort failed, and the dollar finished trading at 75.90 cents on June
28, the lowest point in history, and ended the week at 75.93.
Like a weakened patient gradually being nursed back to health, Canada’s economy has been making a slow recovery for 18 months. But last week’s events
A weak dollar and rising interest rates have spread new anxiety among consumers and businessmen
raised new fears of a serious relapse. In the aftermath of the central bank’s moves, major lenders hiked their prime lending rates to 13 per cent from 12.5 per cent. That, in turn, will mean higher mortgage and consumer loan costs at a time when most Canadians are still feeling the aftershocks of the worst economic slump since the Depression. Last week
the Bank of Nova Scotia led major lenders in raising five-year mortgage rates to 15 per cent. And economists were virtually unanimous in predicting a continued upward trend in borrowing costs, with some experts contending that the prime rate could hit the 16to-17-percent range by mid-1985. In the House of Commons, Conservative finance critic John Crosbie warned that the rise in the bank rate will “bring on a recession that we are just steps away from right now.” Indeed, while there have been signs of a recovery on paper, few Canadians have reaped the benefits. The most troubling indicator: an unemployment rate of 11.7 per cent. Manufacturers and retailers have ridden a consumer spending boom that fuelled the first stage of the recovery last year. But major companies have not made long-term investments in plant and machinery, which would create new jobs for the 1.5 million unemployed. At the same time, the rate of bankruptcies has moderated only slightly. Personal bankruptcies in the
first five months of 1984 total 10,088, compared to 12,611 in the same period last year. Meanwhile, business failures fell to 4,373 from a 1983 level of 4,639.
Because 70 per cent of Canada’s $80 billion in imports comes from the United States—and must be bought with inflated U.S. currency—price increases are inevitable. Consumer reaction was quickly evident. Said Nick Luciano, chief import buyer for F.G. Lister Co. at the Ontario Food Terminal in Toronto, the major clearing house in Canada for fruit and vegetable imports from the United States: “Our sales have dropped considerably as compared to a month ago.” Shoppers will be spared some of the increased costs because cheaper homegrown produce is now on the way to grocery store shelves. “But,” added Luciano, “I am afraid we will be in serious trouble by fall, when we have to go back to buying everything from the United States. The battered Canadian dollar is the culprit.” For his part, Conference Board of Canada economist Stavros Constantinou predicted that a household’s average food bill will rise 7.2 per cent this year, compared to an overall inflation rate of 4.8 per cent.
Other imported products will also cost more. According to an estimate by the Canadian Importers Association last
week, the price of almost all consumer goods in Canada—including food—will rise by two per cent if the dollar remains at its current level for several more weeks. Declared Keith Dixon, president of the 786-member group: “The slipping
value of our dollar against the U.S. dollar is going to have devastating effects on consumer prices.” And because many imports from Japan are also purchased in U.S. dollars, consumers will pay more for videotape recorders, stereo equipment and microwave ovens. Ben Takagi, general manager of finance for Matsushita Electric of Canada Ltd., distributor of Panasonic products, said that his company’s costs have risen 5.6 per cent since January as a result of the dollar’s weakness. Said Takagi: “In some cases we have passed on that cost increase—the consumer is suffering.” In other instances fierce competition in the market has forced the company to absorb the added costs itself.
Influx: But the outlook is not unrelentingly bleak. As the dollar fell, Canadian hoteliers and retailers benefited from an influx of foreign visitors. Between January and April the number of U.S. visitors staying at least one night in Canada was 4.5 per cent higher than it was in the same period in 1983. At the same time, the number of Canadians crossing the border fell 3.2 per cent in April—the first monthly drop in almost a year. “So far, the signs are all to our advantage,” said Peter Chau, a spokesman for the tourism research branch of the department of regional industrial
expansion. Canadian border towns are awash in U.S. dollars.
Said Blair Hoffman, executive director of the Windsor, Ont., Downtown Business Association: “We do not keep statistics, but I did a tour of the parking garage and three out of five of the cars are American.” One local fashion retailer, Barbara Benotto, reported a stunning response from Detroit residents driving across the border to shop: “They love it, they really do. If I were getting 30 cents on the dollar I would shop here too.” However, Mary Oleksik, owner of Mary’s China Shop, noted that the shrinking dollar will ultimately result in an increase in the price of some goods. “Right now we are all benefiting,” she said.“But sooner or later it is going to catch up with us” —when existing stocks of imported china run out and new shipments arrive from overseas.
Other centres across the country are also enjoying an increase in tourism. Frances Hill,
owner of an Indian crafts boutique in Vancouver’s fashionable Gastown district, said that as much as a third of her business this summer is with American visitors. “We have had a lot of them, and they are quite enthusiastic,” she said. In Montreal last week tourists Sam and Brenda Franklin of Fresno, Calif., said they had decided to make a side trip to Canada during a visit to Boston: “It came as a pleasant surprise when the bank gave us 30 cents on
the dollar. It means we can afford to go out and spend more.”
Optimistic: But in addition to a weaker dollar Canadians will also be faced with higher interest rates. In interviews with Maclean ’s, economists predicted a continued rise in lending rates at least until early 1985. The most optimistic scenarios call for prime rates in the 13per-cent range until March, 1985, when they will start to decline. Ben Gestrin, an economist with the Canadian Imperial Bank of Commerce, recently forecast that the rate will reach 13.5 in the next nine months. But last week, in the wake of the latest rise in the bank rate, Gestrin admitted that his prediction was probably optimistic. Said he: “Every day that goes by, we get the feeling that, if anything, we have erred on the side of optimism.” By contrast, Frank Hracs, an economist with McLeod Young Weir Ltd. in Toronto, predicts a 14-per-cent prime rate in the next six months. And by mid1985 he expects it to reach 16 per cent. The resuit, he warns, will be a - renewed recession in is 1986 “as high interest
rates choke off economic growth.”
If that happens, the hardest-hit sector will be the housing industry. Indeed, many analysts believe that mortgage rates have already climbed high enough to deter thousands of potential purchasers. Said Toronto-based housing consultant Frank Clayton: “It is terrible—it is just bad news for people wanting to buy a house.” Clayton’s own studies suggest that an increase in mortgage rates to 16 per cent would reduce the potential number of renters who could afford to buy an average-priced home to 225,000 from 450,000. “The builders are already reporting that traffic has virtually died off,” he said. Clayton’s own advice: “If I were a first-time buyer I would put down a healthy down payment—25 to 30 per cent—and opt for a variable rate mortgage or a one-year term. Sooner or later rates have to start falling again.” Two Toronto people nervously watching the housing market are Jennifer Gottfried, 25, and her husband, Blake. They have combined yearly earnings of $55,000 and they have saved $7,000 toward a down payment of $20,000. With rates now climbing steadily their goal seems remote. “It is discouraging for sure, but we just feel that if we tighten our belts and work hard we will get there eventually,” Jennifer said. Pat Mitchell, a 32-year-old Vancouver Sony salesman, faces renewal of a $55,000 mortgage, currently at 11% per cent, in August. Said Mitchell: “It is a whole
process of timing. You just cannot know from one week to the next what it is going to cost you. I find it frustrating.” Mitchell is especially critical of the federal government for allowing rates in Canada to rise or fall in tandem with those in the United States. “I think that for the overall good of the economy the government should be paying a little less attention to what is going on over the border.”
The United States is in the midst of a
vastly different economic environment. Heavy military spending, healthy corporate profits, strong consumer spending and relatively low wages are fuelling a continuing boom. The nation’s gross national product is growing at an annual rate of 5.7 per cent, compared with Canada’s 2.1 per cent. The unemployment rate in the United States is 7.4 per cent, while Canada’s remains at 11.7 per cent. The U.S. inflation rate is 2.4 per cent; the Canadian rate 4.8 per cent. Still, analysts express concern that the vigor of the U.S. recovery may rekindle inflation. And it is partly to prevent the pace of economic activity from becoming too rapid that banks allow interest rates to climb.
Difficult: There are other pressures pushing up U.S. rates as well. The government’s deficit has climbed to $177 billion, and the United States has to maintain high interest rates to attract capital from other nations to fund its enormous debt load. In Canada’s case the rise in U.S. rates last week took place at a particularly difficult time. The end of the first half of the year is the point at which many Canadian subsidiaries of U.S. firms are required to pay dividends to the parent companies. And the payments have to be made in U.S. dollars, increasing the demand for greenbacks and weakening the demand for Canadian dollars.
The developments placed Bank of Canada Gov. Gerald Bouey in an unusu-
ally difficult position. For several weeks Canadian borrowing costs, determined largely by the bank’s trend-setting rate, had been held slightly below those in the United States, largely to prevent the economic recovery from faltering. But the lower rates made the Canadian currency even less attractive to hold. As a result, when the dollar continued to weaken Bouey raised the rates to a level roughly equal with those in the United States. But his action was not strong enough to reverse the dollar’s downward trend. Declared William Dickenson, a currency trader for the Toronto Dominion Bank: “They will have to do something dramatic or they will still be in the squeeze.”
But Ottawa’s dilemma was of little interest to distressed homeowners like Don Scott, a Halifax chartered accountant. The 25-year-old Scott purchased a $75,000 condominium last year in hopes of protecting himself from the vagaries of the rental market. But now, with a prospect of a $200 increase in his monthly payments when his mortgage falls due on Nov. 1, Scott fears that he may have to sell. Said Scott: “I only chose a one-year term because it was cheap and I speculated that with a U.S. election and a Canadian election, interest rates would hold down.”
Surge: The country’s weakest housing market is in Alberta. In Calgary prices for an average two-bedroom house have dropped by as much as 14 per cent in the past year. “And,” said Claude Root, vicepresident of real estate for Royal Trust, “they have not bottomed out yet.”Added John Riseborough, a sales associate with Re/Max Landan Real Estate: “There was a real surge of activity earlier this year, but right now my electronic pager just is not going off as much.”
Farmers, too, are increasingly pessimistic. Farm bankruptcies across the nation continue to increase. Last year they totalled 488, and in the first five months of this year there have already been 224 farm failures. The conference board’s Constantinou is convinced that a surge in borrowing costs will increase that trend, particularly since interest payments on loans already represent the third-largest share of a farmer’s expenses (after machinery and feed). Said Constantinou: “Rising rates will make a tough situation more difficult.”
For the unemployed the prospect of a general slowdown in the economy means that the chances of finding work are probably worse now than at any time since the beginning of the recovery in early 1983. The unemployment rate among 15to 24-year-olds alone is a staggering 19.3 per cent—a figure that conference board chief economist
Thomas Maxwell contends will gradually climb over the next four years. The reason: a renewed recession in the United States by late 1985 causing a similar downturn in Canada. Maxwell added that thousands of young people who enrolled in universities and colleges to escape the last recession will be leaving school by next year, further glutting an already crowded job market.
The job search has frustrated Brian Burdette, 22, who graduated from Toronto’s York University in May with an honors degree in economics. Originally, Burdette hoped for a position in financial administration but, after applying for more than 120 jobs without success,
he is now willing to work in marketing or sales. “It is easy to fall into the trap of discouragement, but you have to keep slogging,” he said. “Otherwise you wind up watching endless reruns of Batman instead of hustling for jobs.” Still, Burdette is optimistic enough about his chances that he has turned down several less enticing offers. “One guy wanted me to drive around to parking lots selling meat out of the back of a refrigerated truck,” he said.
Among businesses the weakening dollar and the rising cost of money pose a particularly serious threat to retailers of furniture and appliances and, to a lesser extent, auto dealers. Said banker Gestrin: “Rising interest rates cause a psychological malaise to set in among
consumers.” A slowdown in real estate spreads quickly to furniture and appliance sales, he added. In fact, the signs are that after jumping ahead by 9.1 per cent last year, consumer spending will fall off this year. The prospect of rising loan rates is very worrisome to Montreal appliance dealer George Anises, 56, whose store, Grand Appliances Ltd., has been in operation for 34 years. As the cost of borrowing increases, he said, people delay buying such big-ticket items as stoves and fridges. Said Anises: “People get very depressed about it and say, ‘Maybe we will just put off buying an appliance.’ ” Montreal furniture retailer Vera Fischer agrees. For her cus-
tomers furniture is a luxury purchase, and when money gets tight, she said, “People can do without furniture.” Fischer described the recent recession as “murder” for her business. Her sales dropped by as much as 50 per cent, and her own income has dropped to less than $10,000. In the past six months business has picked up, but, concerned about increasing interest rates, she added, “I know that it can’t last.”
Downturn: Even the headstrong auto industry, which recorded a 24.1-per-cent rise in sales last year over 1982, will eventually be hurt as money becomes tighter. Last week Chase Econometrics, a New York forecasting company, said that the downturn may be felt in auto showrooms by early 1985.
But Canada’s major resource companies face the most vexing problems. Still struggling to rebound from a slump that hit them harder and later than the rest of the country, the huge forestry and mining companies that underpin the economy are only now inching back to profitable positions—and are still saddled with enormous debts. The one positive note so far is that the cheaper dollar has helped international sales. Indeed, Inco Ltd. spokesman Ray Gilbert estimated that for each one-cent decline in the Canadian dollar over the course of a year, his company reaps $9 million (U.S.) extra in before-tax revenues. Said Adam Zimmerman, chairman of Mac-
Millan Bloedel Ltd. and president of its majority owner, Noranda Inc. of Toronto: “Broadly speaking, the resource sector benefits more than it loses from the changes so far, but all that could change as rates continue to rise.” In MacBlo’s case, he said, a two-percentage-point rise in rates “would give us another $20 million worth of interest to pay on our floating-rate debt.”
In Ottawa, Prime Minister John Turner and Finance Minister Marc Lalonde insisted that a weak dollar is more acceptable than raising interest rates dramatically to enhance its value. Turner, in his first week as Liberal leader, said that he supported Bouey’s policies and when pressed to say whether he is concerned about the dollar’s fall, he
replied, “No.” But Lalonde also pointed out that because about 70 per cent of Canada’s trade is with the United States, it cannot afford to let the dollar drop indefinitely because of the inflationary impact of more expensive imports.
Despite Lalonde’s statements his officials in the finance department had serious misgivings about Bouey’s high interest rate policy. A mood of tension pervaded the department’s headquarters in downtown Ottawa last week as economists wrestled with the prospect of higher money costs bringing the recovery to a halt. Although officials would not express their views publicly, many believed that a decline in the exchange rate would be a lesser evil than further interest rate increases.
Despair: For the Opposition Conservatives the dollar debate has provoked some apparent indecision. Finance critic Crosbie originally declared that suggestions that the dollar should be allowed to fall indefinitely represented a “counsel of despair.” At the same time, Tory Leader Brian Mulroney said that faced with a choice between higher interest rates and a weakening dollar, he would choose a weakened currency. Then Crosbie shifted his position, saying: “In the present situation the only possible alternatives are to have a lower dollar or higher interest rates. We opt for a lower Canadian dollar.”
For their part, the New Democrats contend that the government should place limits on the amount of money that is allowed to leave Canada. And last week Saskatchewan MP Lome Nystrom said that Ottawa should establish a new speculators’ tax. Based on a measure introduced in the United States by the Kennedy administration in 1963 and repealed in 1974, the program would tax away any extra earnings resulting from
I a spread between high U.S. interest rates and lower Canadian ones on large, short-term investments made outside of Canada. Still, economists differ over the merits of Nystrom’s prescription. Eugene Swimmer, a public administration professor at Carleton University in Ottawa, for one, contended that the central bank should allow the dollar to slide and he acknowledged that a speculation tax could offset the effects. But the plan has major problems, he added. “The tax invites retaliation,” said Swimmer, arguing that the United States might respond with import quotas and tariffs on Canadian exports.
In a similar vein, Edward Shaffer, a University of Alberta economist, contended that currency controls, which would limit the amount of capital flowing out of the country, may be necessary
if Canada is to cut the link between domestic loan rates and those in the United States. Said Shaffer: “I do not like controls but when I measure the three alternatives—controls, high interest rates and a low dollar—I think
they are the least undesirable.” Still, most economists consider exchange controls to be a drastic measure in an industrialized world that has committed itself—in theory, at least—to liberalizing the international trading system.
Dilemma: As economists and politicians debated the causes and prescriptions for the nation’s falling dollar and surging loan costs, many Canadians expressed a growing sense of futility about the future of the economy. And this week Turner, who must now decide when to call a federal election, is clearly aware of that fact. Opposition politicians and Liberal insiders alike agreed that Turner is in a particularly difficult position. Declared Conservative industry critic Michael Wilson: “Turner is on the horns of a dilemma. He is going to get thrown right into the centre of a financial crisis, and in view of that it is not the best time to call an election.” An outgoing cabinet minister, who insisted on anonymity, agreed. “Turner is between a rock and hard place,” he said. “There is no way he could pull the plug this week.” Whenever the election is called, the waves of apprehension and confusion among Canadians over Ottawa’s apparent helplessness in the face of a wounded dollar and surging interest rates will be major issues of contention.
With James Fleming, Barbara Righton and Robert Block in Toronto, Carol Goar in Ottawa, Diane Luckow in Vancouver, Gillian Steward in Calgary, Dale Eisler in Regina, Jennifer Towell in Montreal, Sherri Aikenhead in Halifax and Lenny Glynn in New York.