Volume #15 - 506.|
INTERNATIONAL ECONOMIC RELATIONS
DEVALUATION OF CANADIAN DOLLAR
Memorandum by Department of Finance|
September 15th, 1949|
1. If the pound goes down by 30% in relation to the U.S. dollar, and if other currencies around the world are adjusted to the new position, what should we do?
2. There are only two choices. First, we might try to stay at par with the U.S. dollar. Second, we might revalue our dollar at some level between the U.S. dollar and the pound.
3. If we choose the second course there is everything to be said for moving our dollar down 10%o in terms of the U.S. dollar. This level is indicated both by economic and financial considerations and also by the provisions of the International Monetary Fund.
4. The problem can be discussed under the following heads:
(a) Continuity of government policy;
(b) The position under the International Monetary Fund;
(c) Stability of exchange rates;
(d) Competitive positions;
(e) Gold mining;
(f) What people expect.
Continuity of Government Policy
5. The present government has, in the past, resisted pressure to write the Canadian dollar down by 10%. This may be advanced as an argument for continuing to keep our dollar at parity with the U.S. dollar.
6. On the other hand, devaluation of sterling by 30% is such a big change that it surely releases us from any previous commitments. In fact, people who have agreed with government policy in the past might conclude that, if we did not change our dollar under these circumstances, we were clinging to our present dollar?parity out of sheer inertia or pure stubbornness.
7. Finally, the government argument in the past has been based on three factors, all of which will be completely changed by a 30% devaluation of sterling. These three factors are:
(i) The position under the Fund;
(ii) The stability of our dollar;
(iii) The satisfactory competitive position of Canadian industry.
The way in which each of these will be changed by the fall of sterling is discussed in the following sections.
The Position under the International Monetary Fund
8. Under the Fund Agreement we cannot even propose a movement of our exchange rate unless our balance of payments is in "fundamental disequilibrium". This has not existed in the past; the Canadian dollar was one of the strongest currencies in the world. Other Member countries, therefore, would have regarded unilateral devaluation of our dollar as a most unreasonable proposal.
9. With sterling devalued by 30%, it is very reasonable to argue that we face "fundamental disequilibrium" if we stick to parity with the U.S. dollar. This point is elaborated below.
10. We are allowed by the Fund Agreement to proceed with a devaluation of 10% without discussing the matter with the Fund authorities; we simply tell them what we are doing. If we go beyond 10% (either at one jump or after a series of steps) we must get the Fund's agreement. It is, therefore, better and quicker to operate under (i). This is a telling argument for devaluing 10%, but not more than that.
Stability of Exchange Rates
11. It may be argued, in favour of sticking to parity with the U.S. dollar, that this gives continued "stability" to our dollar.
12. This stability is, however, largely an illusion. There can be no such thing as real stability for our dollar when the two major currencies shift in terms of each other. If we stick to one we move in terms of the other; it is unavoidable.
13. Historically, each major currency has been about equally important in our trading and financial relationships. It is no accident that, when exchange rates were free to fluctuate during the 1930's, the Canadian dollar generally moved "half?way between" the pound and the U.S. dollar. Nowadays our relations with the U.S. dollar are on balance more important. It is, therefore, reasonable to stay "closer" to the dollar than to the pound. This rather suggests a policy of moving (say) 10% down in terms of the U.S. dollar and 20% up in terms of the pound. For us this may be our best approach to "stability".
14. When a country writes down its currency its producers are normally put in a stronger competitive position. They can "undersell" foreign producers, both in their home market and abroad.
15. This competitive advantage, of course, is often merely a "temporary" one; it only lasts until the effects of depreciation have "worn off". The effects wear off when wages and other costs rise sufficiently to offset the initial advantage. This may take years. It depends in large measure on the behaviour of trade unionsespecially in a highly industrialized country like the United Kingdom.
16. Depreciation of the pound in terms of the U.S. dollar improves the competitive position of U.K. producers vis?ii?vis U.S. producers in all markets where their goods compete. Canada is one of those markets. Indeed the U.S. and the U.K. are the two biggest external suppliers of manufacturers to our market. Thus depreciation of the pound will let some British goods push some U.S. goods out of our market. This is doubly desirable; our dollar?imports from U.S. are cut down; our sterling imports from U.K. are increased.
17. All this happens irrespective of the level at which we decide to put the Canadian dollar. The position of our dollar affects, not the relative competitive position of U.S. and U.K. producers, but the competitive position of our own producers in relation to them. It affects the position of our producers both in our own home market and abroad.
18. Take first Canada?U.K. competition. This competition takes place chiefly in the Canadian market?not in the U.K. or in other markets abroad. It is chiefly, almost entirely, in the field of manufactured goods sold in Canada. To the extent that our dollar follows the depreciation of sterling it wipes out the competitive advantage of U.K. producers vis?a?vis our own producers. It does not, however, wipe out the competitive advantage of U.K. vis?A?vis U.S.
19. Next, take Canada?U.S. competition. Unlike the Canada?U.K. competition, it is not virtually restricted either to the Canadian market or to manufactured goods. There is competition of many types in many markets: in manufactures and in forest products and in base metals and in agricultural products; in Canada, in U.S.A., and in other parts of the world. Surely depreciation of our dollar by 10% would give us a competitive advantage in all these fields.
20. It is clear from the two preceding paragraphs that a 10% depreciation of our dollar is much more significant in relation to our dollar?trade than to our sterlingtrade. The former trade is much larger, and depreciation directly affects a much larger proportion of it.
21. While we would like to give U.K. producers every advantage under present circumstances, we cannot afford to ignore the position of our own producers, especially those on whom we depend for our earnings of U.S. dollars. Our outlook for dollar earnings is not too bright; the U.K., from whom we always receive a large part of our dollar supplies, is cutting down her purchases from us because she is so short of dollars. In this position a 10% devaluation of our dollar should prove of very real value to us; it checks our imports from the south?makes them more expensive; it encourages our exports in that direction?makes them more profitable. Surely we should not refrain from this step merely because it will eliminate some of the advantages that the U.K. producers will be getting in our market. (It eliminates none of their new advantage vis?i7?vis U.S. producers and only eliminates one?third of their new advantage vis?A?vis our own producers).
22. To sum up: if the pound goes down 30% and our dollar goes down 10% the following positions result:
(i) The U.K. manufacturer has a 30% advantage over the U.S. manufacturer in the Canadian market (and elsewhere);
(ii) The U.K, manufacturer has a 20% advantage over the Canadian manufacturer in the Canadian market (and elsewhere);
(iii) The Canadian producer (manufacturers and others) has a 10% advantage over the U.S. producer in the Canadian market (and elsewhere, including the U.S. market).
23. This appears to be a satisfactory trading position, from the point of view of ourselves and others concerned, and is probably as near to a position of "fundamental equilibrium" as we could get.
24. Our gold mining industry would get a 10% advantage from a 10% writedown of our dollar. This would last until it wore off as a result of increasing costs of labour, materials, etc.
What People Expect (or: Haw Expectations can be the Chief Cause of their own Confirmation)
25. Almost everybody, surely, will expect the Canadian dollar to move when sterling moves. The financial people will expect it; they will know that, historically, our dollar has hung half?way between the two major currencies.
The business people will expect it; it makes sense in terms of our trading position both with the U.S. and the U.K. The gold miners will expect it; they want it.
These expectations cannot be ignored.
26. If sterling goes down and our dollar stays fixed temporarily, everyone will expect our dollar to go down soon. Everyone abroad who has to buy Canadian dollars?for any purpose?will delay, hoping to get them cheaper. Everyone in Canada who has to buy foreign currencies?U.S. dollars or sterling or anything else?will do it as quickly as he can, fearing that those currencies will soon be more expensive. Thus F.E.C.B. becomes a one?way street; all outlet and no inlet. And so our reserves start to fall.
27. This soon becomes known; our next public announcement of our reserve position has to be made at the beginning of October. Everyone is then confirmed in his conviction that the Canadian dollar will soon have to written down. A new set of expectations is set up; the circle starts another turn.
28. And so it is likely to go?round and round?self aggravating?a downward spiral?until we, like the U.K., eventually slip over the brink into devaluation. Meanwhile, we lose precious reserves. We would do well to write them up (writing down the value of our dollar in terms of them) at the outset. When we do so we make a nice paper-profit.
29. "If it is done when 'tis done, then 't'were well it were done quickly".