Defending the dollar

MARY JANIGAN February 17 1986

Defending the dollar

MARY JANIGAN February 17 1986

Defending the dollar


It was a high-stakes showdown. When the Canadian dollar tumbled below 70 cents U.S. early last week, Finance Minister Michael Wilson predicted that speculators betting on its decline would suffer. Then, less than 24 hours later Wilson launched a lightning counterattack to support the dollar. In a series of worldwide manoeuvres the government, through the Bank of Canada, drew $1 billion in U.S. funds from its $7.5-billion line of credit with Canadian and foreign banks. And it offered a $l-billion bond issue to attract U.S. dollars in Europe— the largest foreign issue ever floated by the government. The Bank of Canada drew on that $2billion war chest to buy Canadian dollars, driving the dollar from a record-low close of 69.24 cents on Tuesday to a close of 70.42 cents on Wednesday—one of the largest single-day increases in its history.

Then, the bank pushed its interest rate from 10.8 per cent to 11.47 per cent to make Canadian dollars even more alluring. “The Bank of Canada came into the market with every weapon it has,” said Steve Bennett, chief money market dealer for the Canadian Imperial Bank of Commerce.

“Wilson has taken a hammer and tried to bust every one of the speculators’ fingers.”

In fact, Maclean's has learned that Bank of Canada officials told international traders two weeks ago that it would protect the dollar. In the past similar warnings have gone unheeded. But the ferocity of Wilson’s counterattack stunned speculators. Unlike previous attempts to prop up the dollar, the bank did not resell its Canadian cur-

rency when the dollar rose. Said one money trader: “There was absolute malice in his action. The next time he makes those calls the markets will listen.”

By week’s end, the dollar had rallied

to 71.07 cents U.S. The drama left many Canadian businessmen uncomfortable, because the sudden swings affect their cost of doing business. But the major long-term impact may become evident in this month’s federal budget. In early January Wilson was facing tough cabinet opposition to his plan for major cuts in the estimated

1986-87 deficit of $32.7 billion. Then the dollar began to fall—and many economists attributed that fall, in part, to a concern among money traders that the cabinet was not going to take a tough stand on the deficit. Tory insiders said the situation surprised many ministers: they realized that the dollar’s fate— and their political survival—could depend on tough budget cuts. As a result, they yielded to most of Wilson’s requests for further spending decreases and some tax increases.

Wilson and Prime Minister Brian Mulroney are now expected to promote deficit reduction as a means of defending the dollar, improving the economy and producing more jobs. “The dollar’s fall has finally focused attention on Wilson and the deficit,” a Conservative insider said. “Wilson has been able to convey to many colleagues the necessity to reduce the deficit, not necessarily for fiscal responsibility but for political salvation.”

The drop in the value of the dollar to 69.1 cents U.S. from 71.2 cents three weeks ago puzzled many economists, who argue that the Canadian economy is basically sound. Real economic growth of 4.5 per cent last year exceeded U.S. growth. And last week Statistics Canada reported that the unemployment rate had dropped to 9.8 per cent—the lowest since April, 1982.

But some economists pointed out that there were problems ahead—and traders, who buy and sell on the future worth of a commodity, may be anticipating them. Last year Canada had an estimated $19-billion surplus of exports over imports. But its current account—the measure of trade in all goods and services, including dividend payments by Canadian subsidiaries to foreign parent companies—plunged from a $2.6-billion surplus in 1984 to a $1.9-billion deficit last year.

As well, traders were concerned that a worldwide collapse in oil prices could weaken the Canadian economy. Last week oil prices dipped to a seven-year low of $15.44 (U.S.) a barrel. Edward Carmichael, senior policy analyst at

Toronto’s C.D. Howe Institute, pointed out that prices for natural gas, electricity and coal—all major Canadian exports—usually follow oil prices. “Currency traders have the perception that Canada is a producer of raw materials and energy,” said Carmichael. “So it is

not unusual to see the _

But many economists question that perception. Michael McCracken, president of Ottawa’s Informetrica Ltd., pointed out that 73 per cent of Canada’s exports are manufactured goods —so lower oil prices would be a net benefit for Canada.

Many economists also said that some currency traders had decided that Ottawa would do—and could do—little to stop the dollar’s slide. About half of the 19,000 Canadian currency contracts on the Chicago Mercantile Exchange last week were held by three trading houses, which were

clearly betting that the dollar would continue to fall. When the bank supported the dollar, that perception began to alter.

That tough action will be backed by deep budget cuts, insiders say. Wilson fought throughout the early winter for those cuts. But some powerful cabinet members—including Employment Minister Flora MacDonald and Health Minister Jake Epp—argued that the government should concentrate on fos-

tering economic growth to increase tax revenue and gradually erode the deficit. The battle raged into 1986—until the dollar’s slide accelerated. Insiders say the crisis convinced Mulroney that Wilson was right.

At the same time, Mulroney’s office is

_ consulting with deputy

fairness finance minister Stanley Hartt to ensure that the budget does not contain any political liabilities. Last summer angry pensioners forced Wilson to cancel a budget measure to limit automatic increases in old-age pensions. “Michael has an acute understanding of the economic issues,” said consultant Sam Hughes, president of Executive Consultants Ltd. of Ottawa and the former president of the Canadian Chamber of Commerce. “But when you add the political perspective, he is not going to get everything he wants.”

Wilson’s behind-the-

scenes victory carries political risks. In many polls conducted by Decima Research Ltd. of Toronto, the Conservative party’s polling agency, most Canadians say that the deficit is a major problem. But when Decima asks Canadians for their reaction to specific spending cuts, the support for deficit reduction disappears. David MacNaughton, chairman of Public Affairs Resource Group, which owns Decima, says that the dollar’s fall has created a public opinion climate that may help Wilson tackle the deficit. “The problem up until now was that there was not enough linkage between deficit cutting and the health of the economy in the public’s mind,” he told Maclean’s. “Now the government can show that deficit cutting is a means to achieve a healthy economy and more jobs. But the cuts— and any increased taxes—must be perceived as fair.”

That issue of fairness has preoccupied the Conservative caucus. Many MPs have pressed Wilson to ensure that the budget contains few tax increases for ordinary Canadians. Instead, they want Ottawa to abolish corporate tax loopholes—and cut costs across the board instead of cutting individual programs. Said Saskatchewan Tory MP Geoffrey Wilson: “I question whether there is a capability to tax Canadians to a much greater extent. What I hear from most people is that they feel they are paying their share.”

But many businessmen say that they will welcome decisive measures to stabilize the currency. Christopher Trump, vice-president of Spar Aerospace Ltd., said that currency fluctuations are a problem for companies doing business abroad. “Nobody is able to actually figure out what the price is—it becomes like a lottery,” he complained. “And when a country’s currency is on the skids, there are messages sent that make it more difficult to do business.”

That impression may change if Wilson and Mulroney unveil a tough package of deficit-reduction measures—and then go across the country promoting them. The success of their mission may determine the health of the Canadian dollar—and even the fate of the Conservative government.

-MARY JANIGAN with MARC CLARK in Toronto and PAUL GESSELL in Ottawa