Answering your questions about the Canadian dollar:
Is the Canadian dollar in a slump because the Canadian economy is weak?
No. The Canadian dollar is in a slump because the American dollar is strong.
Why is the American dollar strong?
The American dollar is strong because of the American deficit.
In other words, the American deficit is coming down and business confidence is up, and that makes the American dollar strong?
Not exactly, no. The American deficit is higher than it has ever been, and business confidence has been better.
How does shaky business confidence make the American dollar go up?
Because Americans are afraid the high deficit is going to force the government to raise interest rates.
If high interest rates are bad for an economy, how can they help the dollar?
People who invest using American dollars get a higher rate of return because of the high interest rates. So more people are buying U.S. dollars to invest. That makes the U.S. dollar strong.
Would Canadians be among those who buy American dollars?
This has been a good way for Canadians to get rich. They sell Canadian dollars and buy American ones to take advantage of the high interest rates.
Is this a patriotic thing to do?
Some people think not. Buying American dollars forces the value of Canadian dollars down. Then Canada has to raise its interest rates in order to keep the value of the dollar from falling still further. Other people think that, unwittingly, those who sell Canadian dollars are doing their country a favor. By forcing the value of the dollar down, they are making Canadian exports more attractively priced, and this helps the export industries. At the same time, a lower Canadian dollar makes imports more expensive so Canadians buy fewer of them and more products that are produced at home. So you could say that the people who secretly feel ashamed of themselves for selling Canadian dollars and buying American ones are really doing their country a favor.
Has the Canadian government ever given any medals to those people?
Not as far as anyone knows.
But the Canadian government must be happy that the dollar is dropping.
The Canadian government is never
happy about the dollar dropping. No matter which party is running the government, it just doesn’t feel right, somehow. Through the Bank of Canada it keeps trying to prevent the dollar from dropping more by raising interest rates.
How does this help?
It helps by making investment in Canada more attractive because of the high interest rates. So more people, including foreign investors, buy Canadian dollars in order to invest here.
So keeping the Canadian dollar up by raising interest rates increases the amount of foreign ownership?
That is correct. But the economy is stronger, even if we don’t own it.
To go back to the American deficit—why is it so high? Isn Ï the President a fiscal conservative who believes in balanced budgets?
The President also believes in defence. The defence budget is what drives his deficit up.
‘The purpose of the Star Wars plan is to frighten the Soviets with the thought that the system might be buiW
Why is the U.S. defence budget rising?
The U.S. defence budget is rising because of the so-called Strategic Defense Initiative, a plan to put high-powered gizmos —excuse the technical jargon—in outer space to shoot down enemy missiles before they can do any damage.
Is this known as the Star Wars plan?
Crudely, yes, by headline writers who can’t fit Strategic Defense Initiative into a two-column space.
Is the Strategic Defense Initiative a practical plan?
If you understood defence planning you wouldn’t ask such a question. It doesn’t matter whether it is practical or not. The purpose of the Strategic Defense Initiative plan is to frighten the Soviets with the thought that it might be built. It is better not to build it, because if it is built the threat of building it is not so good any more.
Does Canada support the Strategic Defense Initiative?
Canada supports Star Wars as a research project. Canada has not decided what to do if the research project is successful and the Americans actually
decide to build the thing.
Is this an unusual position for Canada to be taking?
In the light of the history of Canadian policy toward the United States, no.
Isn ’t this discussion getting a bit away from economics?
Certainly not. It all has to do with the deficit.
Would it be fair to say, then, that because of the Star Wars plan the American deficit is going up, causing American interest rates to go up, causing the American dollar to go up, causing the Canadian dollar to go down, causing Canadian interest rates to go up? And would it be fair to conclude that Canadian interest rates going up will cause the Canadian deficit to go up?
Yes, because the Canadian government will be forced to pay higher interest rates on the money it owes and because higher interest rates slow down economic growth, thereby causing less money to be collected in taxes.
So the Canadian government, by supporting Star Wars...
Only as a research project.
So the Canadian government, by supporting Star Wars only as a research project, is supporting a weaker Canadian dollar, higher interest rates and a higher deficit?
Does the government know this?
The Canadian government has many things to think about, and this may have slipped its mind.
What other things does the Canadian government have to think about?
It has to think about its relationship with its most important ally and trading partner.
Does this mean it would make the Americans mad if we did not support Star Wars?
This is difficult to know. If the Americans were to become angry, however, there could be severe consequences.
They could raise interest rates and cut off American investment in Canada.
What would be the impact of this?
The Canadian dollar would drop, and we would have to raise interest rates.
But isn’t that already happening anyway?
But we’re supporting the plan?
Only as a research project.
Yes, but we’re supporting it anyway?
Certainly. What are friends for?
Charles Gordon is a columnist for the Ottawa Citizen.
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