US economic shock waves buffet Canadian dollar
The shockwaves from the events shaking the United States economy are being felt by Canadians, who also face another year of soaring prices, stagnant economic growth, and high interest rates in 1980.
With rising US short-term rates threatening the stability of the Canadian dollar, Ottawa was forced into action less than a week after the new Liberal government took office. In a surprise move Monday, the government unpegged its central bank rate for the first time in two decades.
Canadian rates, which usually move up in concert with those in the US, are at record levels, with prime commercial loans bringing 15 per cent or more. But even at the level, Canada was out of phase with the US, where the prime rate had risen to 17.75 per cent.
The result was a rapid plunge of the Canadian dollar. It fell below the 86 -cent US level on exchange markets last week for the first time since January -- and a widespread expectation that the Bank of Canada would quickly jack up rates here.
Instead, the central bank opted to allow the bank rate -- which influences other borrowing costs -- to move up and down with market forces until further notice. Spokesmen for the opposition political parties immediately charged the Liberals with trying to sidestep responsibility for unpopular interest rate hikes.
Canadians have seen 10 central bank rate jumps in two years, and coping with public anger over skyrocketing borrowing costs is but one pitfall ahead of the new finance minister, Allan MacEachen, an ally of Prime Minister Pierre Trudeau and a veteran of more than 30 years in Parliament.
In his first budget message, expected sometimes before the end of the summer, Mr. MacEachen will have to deal with an economy that has settled into a four-year slowdown. From 3.4 percent in 1978, growth last year slid to 2.9 percent.
This year, growth will probably fall short of 1 percent. Behind the slump are low levels of spending by governments and consumers. Last year consumer purchasing rose by only 2.3 percent, one of the smallest increases in two decades.
Expansion in 1980 will depend greatly on whether a recession materialized in the US, destination for 70 percent of this country's exports. Because of the unexpected resilience of the US economy in the second falf of 1979, Canada posted a record merchandise trade surplus of $4.1 billion in 1979 (compared with
Partly because of this trade performance, Canada was able last year to reduce its current account deficit to $5 billion, compared with $5.3 billion in 1978. This was despite an expansion in interest and dividend payments to foreigners and other services transactions, which reached a total deficit of $9.6 billion in 1979, up from $8.7 billion the previous year.
A major source of strength in the Canadian economy again this year will be private sector investment. Real business spending on equipment and plant is forecast to rise by 7.2 percent, following last year's real increase of 10 percent.
Little improvement in inflation is expected in 1980 over last year's consumer price rise of 9.8 percent. And the country's unemployment picture, which dropped to 7.5 percent in 1979, is expected to worsen in coming months as the economy tapers off, possibly reaching 8.5 percent by year end.
All these forecasts could be quickly nullified by fast-moving economic events in the US, particularly president Carter's attempts to deal with inflation. Until the US situation clears, any strategy for fighting soaring prices in Canada will be held off.
"I'm not sure what the US is going to do and how successful they are going to be," remarked Mr. MacEachen last week.
The new finance minister approaches his job with almost a blank slate. Aside from a pledge of higher pension payments, to be funded by a $500 million increase in corporate taxes, Prime Minister Trudeau made few spending promises in the election campaign. The Liberals preferred instead to attack ousted Conservative Prime Minister Joe Clark's politically disastrous budget policies, which were centered on sharply higher energy prices and cutbacks in government spending.
While declining to promise to trim federal outlays as the Tories did, Mr. MacEachen has ruled out new programs that would expand the federal government deficit, now estimated at about $11 billion annually. However, without new taxes or cutbacks in existing programs, his government will have trouble keeping a lid on the deficit, sine subsidies paid by Ottawa on imported oil for eastern Canada have escalated dramatically in the past year.
How successful the Liberals are in holding down the deficit will be watched carefully by foreign investors and is sure to affect the value of the Canadian dollar. If recent speculation over a major oil find off the east coast of Newfoundland pans out, the Liberals could benefit.
Already, the dollar's status as a potential "petro-currency" has made life easier for the country's central bank officials. They were able to put off action on interest rates for weeks because, until last week, the massive influx of foreign funds to buy Canadian-listed energy stocks kept Canada's currency stable.