COLUMN

Tough decisions about the dollar

Dian Cohen February 10 1986
COLUMN

Tough decisions about the dollar

Dian Cohen February 10 1986

Tough decisions about the dollar

COLUMN

Dian Cohen

It was only 10 years ago that the Canadian dollar was worth $1.04 (U.S.). Last week our embattled currency struggled to stay above 70 cents. That represents a drop of 32 per cent in the past decade, six per cent in the past year alone. Pension fund managers say that if it were not for the fact that they are prohibited by law from allocating more than 10 percent of their assets to non-Canadian investments, virtually none of the hundreds of millions of dollars now under their management would be invested in Canadian corporations and government bonds. Finance Minister Michael Wilson says that the dollar’s free fall is not his fault. The Canadian dollar has been declining against its American counterpart for a decade; he has only been finance minister for a little more than a year. That, one assumes, must prove that it can’t be his or the Conservative government’s fault.

Many Canadians, preoccupied with winter vacations in warm but increasingly expensive U.S.-dollar-linked resort islands, must be wondering what is going on. What is clearly going on is that longand short-term investors alike are turning their backs on the Canadian economy.

Short-term investors—people who place their money solely on the basis of the interest rate they can get—are investing elsewhere, such as in the United States. The lack of public confidence has reached the point where officials of the Bank of Canada have expressed concern that $900 million committed by small investors in Canada Savings Bonds (CSBs) has been cashed in the first three weeks of January. Ordinary Canadians, who have traditionally favored CSBs as a reliable investment vehicle, are beginning to favor more attractive short-term alternatives that pay higher yields, such as guaranteed investment certificates issued by trust companies and money market funds. To prevent an even more serious run on CSBs, which could interfere with the government’s supply of funds, the Bank of Canada may have to consider raising the rate of return on the venerable CSB in the coming months.

Meanwhile, the outlook for longterm investors—the kind who seek to make profits by allocating their money for 10, 15 and 20 years so that the country can modernize, restructure

and develop resources at a profit— seems even more gloomy. Many are saying that they have little faith that they are ever going to realize an acceptable return on investment.

Is the Canadian government to blame? Specifically, no. In general, yes. Specifically, speculators who play the money markets can temporarily drive down a vulnerable currency. But they cannot keep it down if it has a higher perceived value. That has happened to the Canadian dollar in the past, when the dollar dropped from $1.04 in 1974 to 97 cents in 1975 because of speculative pressure. By 1976 it had rebounded to $1.04. And it is, to a degree, what has happened in recent weeks when speculators bet that the Canadian government would not let interest rates rise and would allow the dollar to drop.

In general, however, the Canadian government is responsible for the do-

The Canadian dollar has been declining for a decade because investors have lost conñdence in the nation's economy

mestic and international perception of the currency. Today, as 10 years ago, Ottawa is responsible for the general economic environment. That environment includes a perception that the Canadian economy will continue to weaken, and that the tax and interest rate policies in place are inappropriate. That perception is based on the fact that this year more than $1 billion extra will be siphoned out of the pockets of consumers and into the coffers of the federal government—through a new manufacturers’ sales tax hike, a new surtax on “high” incomes and general income tax increases. Despite such an enormous amount of money entering federal coffers, there is a parallel perception that Ottawa will do little to reduce the nation’s mountainous deficit.

In addition, there is a widespread belief that our single source of pride— our trade surplus—is rapidly being eroded. From December, 1984, it shrivelled by $3.6 billion to $15.5 billion just 12 months later. As if this weren’t enough bad news, investors seem convinced that the federal government has overtly decided that the proper

way to address the deficit is to rely on still higher taxes rather than on tougher-to-make spending cuts—or, at the very least, on a combination of higher taxes and deeper spending cuts. Without question, higher taxes and higher interest rates add considerably to the cost of doing business in Canada. These factors are far more influential in the investment decision-making process than the benefits of a small improvement in the inflation rate. Similarly, they have more effect than the slightly more receptive attitude of this government to foreign investment compared to its Liberal predecessor.

Here is a situation in which perception governs reality, and perception is what is encouraging speculators to flood the currency markets with unwanted Canadian dollars. The coup de grace today is the clear belief that the Bank of Canada will be reluctant to allow Canadian interest rates to rise. This is probably a correct assumption. By raising interest rates when the jobless rate is still higher than 10 per cent, the government will not encourage job creation. At the same time, it would only further hinder Canadian companies staggering under a burden of corporate debt greater than that of U.S. firms.

But even if the Bank of Canada governors are reluctant to raise interest rates, they must come to terms with the painful correlation between interest rates and the value of the dollar. Just to slow the descent of the dollar the central bank will have to widen the present narrow gap between American and Canadian rates.

Although the federal government refuses to acknowlege that the Canadian standard of living is declining, Canadians can see the stark facts for themselves. When compared to GNP, our $40 billion in government deficits has put us near the top of the heap of nations burdened with high levels of debt. Since we also have one of the worst records of manufacturing productivity in the industrialized world, a drastic restructuring of the economy is necessary—not just to make Canada an interesting place to invest but to prevent us from getting a lot poorer. That restructuring involves the tax system, the social security net, federal-provincial arrangements and all the other issues we love to ignore. It is becoming increasingly difficult to keep up the pretence.

Dian Cohen is a Montreal-based economics writer