COVER

Hard choices for a soft dollar

BOB LEVIN January 27 1986
COVER

Hard choices for a soft dollar

BOB LEVIN January 27 1986

Hard choices for a soft dollar

COVER

With the Canadian dollar plunging to historic new lows, the pressure to do something is overwhelming—but exactly what is a thorny question. For now, the Bank of Canada has moved to shore up the sagging currency by allowing interest rates to rise, a move designed to make the dollar more attractive to investors. For his part, Finance Minister Michael Wilson offered assurances last week that the government was committed to reducing the federal budget deficit, which, analysts said, had damaged the dollar by undermining confidence in the economy. Still, some economists doubt that those developments will make the decline of the dollar stop at the current 71 cents U.S. And the actions will not likely silence debate over an issue that has long divided importers and exporters, Liberals and Conservatives.

Intervention: Some economists do not even view the dropping dollar as a cause for alarm. Michael Walker, director of the Fraser Institute in Vancouver, rejected the implication “that there is something inherently good or bad about movements of the Canadian dollar.” Walker contended that the central bank should not intervene to prop up the dollar, an action, he says,

that only encourages more speculation.

Some economists who once supported intervention now say that with four per cent inflation, the dollar should be allowed to float. “Canada should quit using the currency as if its manhood is being challenged,” said Carl Beigie, director of Toronto investment firm Dominion Securities Bitfield Ltd. “There is no basis for permanent defeatism.” Dropping: Still, there are distinct advantages from a falling dollar.

The chief beneficiaries are exporters in resource industries, whose products become cheaper in the U.S. Other gainers are those who export their goods but do not rely heavily on imported materials to make their products, while bargain-hungry travellers cause the Canadian tourist business to boom. Said Richard Harris, a Queen’s University economics professor: “Many people owe their jobs to a 70-cent dollar.”

But there are plenty of losers, too. The wounded currency is disastrous for importers, who pay out more dollars on foreign markets and pass on the higher costs to consumers. And

that could lead to an increase in inflation for a Canadian economy in which 70 per cent of the annual $80 billion in imports comes from the United States.

That scenario is precisely what the Bank of Canada wants to avoid. As a result, it raised its prime lending rate—the rate at which it lends money to financial institutions—to 10.38 per cent last week, up from 10.21 per cent the previous week. But that action could backfire by undercutting business investment and slowing the jobcreation rate. It will also lead to higher mortgage rates—the major banks have already announced increases— consumer loan costs and, possibly, reduced spending. Indeed, higher interest rates could reverse an economic recovery during which unemployment dropped to 10 per cent last month, its lowest level since April, 1982. But Wilson, who confers regularly with Bank of Canada governor Gerald Bouey, insisted last week that both the dollar crisis and the increased interest rates were merely short-term fluctuations. “Stability,” he said, “will return.” Alter: Other analysts are not so optimistic. They say the problems that led to the dollar’s fall are deeply ingrained. And while the government can do nothing to affect the decline in world commodity prices, which underpin Canada’s resource-based economy, critics say Ottawa must alter the perception that it is not as intent on belttightening as is the United States. Last May the government predicted that the current year would see a $3billion drop from the fiscal 1984-85 deficit of $36.9 billion, and it has pledged a further decline for the next fiscal year. But many observers doubt the budget-cutting commitment of Brian Mulroney. “So far the Prime Minister has been oscillating,” said Andrew Alleyne, senior economist at the Toronto Dominion Bank.

There are other, more extreme ways to prop up the dollar. In the past New Democratic Party leaders have called for limits on the amount of money that is allowed to leave Canada and a tax on extra income earned as a result of higher U.S. interest rates. But Washington might well retaliate with protectionist measures, and currency controls are anathema to the Conservatives. For now, Ottawa seems determined to ride out the crisis on its middle road, hopeful it will not lead to an even deeper hole for the dollar.

ANN WALMSLEY

-BOB LEVIN with ANN WALMSLEY in Toronto and correspondents’ reports