Volume #16 - 425.|
ORGANISATIONS ET CONFÉRENCES INTERNATIONALES
INSTITUTIONS SPÉCIALISÉES DES NATIONS UNIES
FONDS MONÉTAIRE INTERNATIONAL
Adjoint exécutif du gouverneur de la Banque du Canada|
au greffier du Conseil privé
le 23 août 1950|
Dear Norman [Robertson],
I thought that you might be interested in seeing the attached memorandum regarding the discussions with U.S. officials and the Fund on the subject of the exchange action taken by the Government at the end of September.
[Ottawa], October 21, 1950
REPORT ON WASHINGTON DISCUSSIONS RE FLOATING THE CANADIAN DOLLAR SEPTEMBER 28 30, 1950
1. In accordance with Mr. Abbott's instructions, I saw Mr. Snyder, Secretary of the Treasury, on Friday, September 29 at noon and explained to him the reasons which had led the Minister of Finance to the conclusion that Canada should give up the existing exchange rate for the Canadian dollar without for the time being fixing a new one. The explanation was along the following lines.
During the last few months there has been a very heavy speculative inflow of U.S. funds to Canada. The speculation has been based upon the expectation that the Canadian dollar would soon be restored to parity with the U.S. dollar. Articles encouraging such thoughts have become very common in the press in recent months, including N Y Herald Tribune, N Y Times, N Y World Telegram & Sun, Journal of Commerce and even Walter Winchell has told his 3 million radio listeners that this is what they may expect. Investors and others have sought to profit from the anticipated move in our exchange rate in various ways by converting U.S. funds into Canadian and collecting the 10 per cent premium and buying securities, mainly Government securities, or simply leaving the money on deposit, in the expectation in many cases that when the rate was changed they would sell the securities and cash in on the profit. The speculative movement has of course affected Canadians as well who have sought to derive the maximum benefit from the anticipated change or protect themselves from its adverse consequences, e.g. importers, exporters, inter company accounts.
The result has been a very sharp increase in our gold and U.S. dollar holdings.Position Change ($ millions) End 1949 1,117 May 30, 1950 1,182 June 30 1,255 73 July 31 1,320 65 Aug. 31 1,504 184 Sept, 27 1,797 295
This speculative movement started in June. Our reserves went up $75 million in that month and $65 million in July. While we welcome the inflow of capital for productive purposes, a hot money inflow is not welcome. For one thing it is costly we pay on the average, say 3 per cent on the funds invested and we earn only 1 1/4 for every $100 million capital inflow of this sort we are therefore out of pocket nearly $2 million. However, in spite of this and the other disadvantages of a hot money inflow, the first decision of the Minister was to ride the thing out in the hope that the inflow would peter out.
But far from petering out, the inflow has constantly stepped up in tempo. In August it was 184 million and so far in September over 300 million and it doesn't show the slightest sign of abating.
In the last 3 months alone we have added over $550 million to our reserves. As our current account surplus has been negligible the whole of this can be attributed to capital inflow. To get some idea of the magnitude of the problems this has created for us and to convert this into equivalent American terns you should multiply this figure by about 18 which is roughly the ratio of the American national income to the Canadian. It is as though the United States was called upon to add $10,000 million to her monetary gold stocks in a 3 month period, and this without any sign of the movement tapering off.
The Minister has become increasingly concerned with the inflationary consequences of this speculative inflow of funds. It is his opinion that the present situation calls for anti inflationary fiscal and credit policies, that our economic and financial policies should be based on the assumption that the cold war will last for many years and that a strenuous effort will be called for for some time to come. This attitude is reflected in the recent tax increases imposed at the special session of Parliament in order to retain a budgetary surplus in the face of large defence appropriations.
The massive inflows of funds threaten this anti inflationary policy. Those who sell bonds to American investors come into possession of cash which they wish to re invest. A downward pressure on interest rates is exercised at a time when this is least desirable.
The Bank of Canada has done its best to offset the inflationary consequences of the inflow of funds and it has managed to keep the banks' cash reserves from rising by more than $5 million since June 30, even though inflow of funds requiring to be offset exceeded in amount the total deposits held by the commercial banks with the Bank of Canada on June 30. But in spite of heavy sales of securities all the Bank of Canada has been able to accomplish on the long term side has been to prevent interest rates from falling by more than a fractional amount. For example our 3's of 66 which were selling on June 30 at 102 1/8 to yield 2.78 are now selling at 102 7/8 to yield 2.70. And even this modest result has been accomplished by acting extensively in the field of short term rates where more ammunition was available. These rates have been pushed very high, e.g., the 3's of 53/56 are yielding 2.45 per cent for a 3 year security.
The inward pressure of funds shows no signs of abating and the Minister has reached the conclusion that we can't go on on the present basis. Something must give. In a sense we have the bear by the tail and we have to let go. The only question which arises is where will we wind up when we do let go.
All the speculation is that we will return to parity with the U.S. dollar and that is in fact the only fixed rate worth considering. Any intermediate point such as a 5 per cent premium on U.S. funds would be regarded as the first bite of the cherry and would encourage further speculation.
A return to parity would in fact put an end to the speculation and it would help deal with the inflationary situation which is causing the Minister concern. At the same time the Minister has reached the definite conclusion that he could not recommend this course of action to his colleagues.
His main reason for reaching this conclusion is that there is nothing in Canada's current account position in relation to the rest of the world which would justify him in arbitrarily raising the value of the Canadian dollar by 10 per cent at this time. Our over all international trade position is worsening and not improving. In the first 8 months of this year we had an over all trade deficit of $17 million compared with an over all surplus of $83 million in the same period last year a worsening of $100 million. Our estimated over all current account surplus for 1950 is only $70 million, compared with $180 million in 1949 and $472 million in 1948. With the further relaxations which are planned in import restrictions and in travel restrictions it would not be surprising if our current account surplus disappeared entirely in 1951.
A return to parity would inevitably be followed by sharp losses of exchange. The speculative capital would be withdrawn, the leads and lags would be reversed and our current account position, already none too good, would worsen and might even run a deficit. It would soon appear and might in fact be the case that we had chosen the wrong rate. The speculative pressures would start operating against us and we might soon be up against the necessity of considering another arbitrary 10 per cent change in the exchange rate.
In thinking of the possibility of returning to parity the Minister is naturally influenced by the experience following our return to parity in 1946. Very soon after that we began to lose reserves rapidly and when they got down to $500 million very drastic action was taken to restrict imports, ration travel, etc., etc. Basically the loss of reserves was due to the fact that the amount of credit we extended to the British, French, etc. to help in reconstruction after the war was in excess of the current account surplus we produced. Nevertheless in certain quarters the entire blame for all the difficulties which arose in those years was attributed to what was described as the arbitrary action of the Government in July 1946 in establishing the Canadian dollar at an "unrealistic" exchange rate. The criticism which was engendered was bitter and extreme and Mr. Abbott feels that he simply could not face Parliament and the public and again announce a return to parity unless he were thoroughly convinced that this was the right rate for Canada. He is not convinced of this and consequently he is not able to recommend this course of action.
This leaves the position then that the present rate cannot be maintained, we are being forced off it by forces too big for us to cope with, and the Minister feels that he cannot in good conscience take the responsibility for recommending parity, the only alternative fixed rate worth considering. By elimination he has come to the conclusion that the only course open to him is the one he intends to recommend to his colleagues tomorrow to abandon the present rate without immediately fixing a new parity. The exchange rate would then be determined by the forces of demand and supply as in a free market, subject to this that in present circumstances the Minister would not expect the Canadian dollar to fall below the present level nor would he contemplate allowing it to rise above parity with the American dollar, and the resources of the Exchange Fund would if necessary be used to accomplish this. The hope of the Minister would be that in due course conditions would show sufficient promise of stability to enable him to fix a definite exchange value for our currency.
You may imagine that Mr. Abbott did not reach the conclusion he did without a great deal of searching of mind and conscience. The exchange system he intends to recommend to his colleagues is not fully in accord with the Articles of Agreement of the Fund, and he is very conscious of this. He does not feel that we are entitled to ask the Fund for its approval when I take the matter up with them tomorrow but he does feel entitled to hope that the Fund will consider our position objectively and in a spirit of understanding rather than one of irritation and resentment.
He feels entitled to hope this because he firmly believes that if you look at the substance of what we are doing it is fully in accord with the purposes and policies of the Fund in which Canada still fully believes. In conjunction with this change the Minister intends to announce certain very important relaxations and liberalizations of our exchange arrangements. He will announce the termination at or near the beginning of 1951 of all remaining import restrictions imposed in 1947. At one time these kept out dollar imports to an amount exceeding $300 million. He will also announce that he has instructed the Foreign Exchange Control Board to liberalize the travel arrangements, and in fact it is intended, within the next fortnight, to eliminate all restrictions on travel expenditures by Canadians in the United States. The new exchange arrangements contemplated will also do away with the unofficial exchange market by merging it with the regular exchange market. This will do away with the dual exchange rate system which has been in effect since the beginning of our exchange control and will enable Americans in a position to withdraw capital from Canada to do so at the same exchange rate as is applied to all transactions.
2. Mr. Snyder listened attentively and sympathetically to this exposition. He reacted as expected to the statement that the increase in our reserves from June 30 to September 30 was equivalent in American terms to an increase of $10,000 million in monetary gold stocks; he found the short term rates on Government securities in Canada high; he remarked on the fact that one could not scientifically determine what was an appropriate exchange rate; and he expressed puzzlement (just before I told him what course of action was proposed) as to what a country in this position, i.e. driven off its present rate and unable to fix a new one, could do. At the end of the exposition, he thanked me for the advance notice and explanation and said he would get in touch with me in the course of the day if anything occurred to him.
3. After the discussion with Mr. Snyder I was able to get Frank Soilthard, the U.S. director on the Fund, to have lunch with me and I covered the same ground with him. He asked a number of searching questions but he was impressed with the magnitude of our problem and was receptive and sympathetic. He told me later in the day that at tire meeting with Snyder and Martin which took place immediately after lunch, he (Southard) expressed the view that looking at the matter from an exclusively American standpoint the floating rate was preferable to parity. Parity, in his judgment, would have been regarded as more of a reflection on the U.S. dollar and as indicating a desire of the Canadians, "our best friends", to exploit the defence effort of the United States by getting better terms of trade. Southard repeated these views at the Fund Board the next day when he also made it clear that if the Canadian Government had decided to restore the currency to parity with the U.S. dollar, his Government would not necessarily have opposed the move. Southard was at pains to make it clear to me that U.S. support was based on the thought that the floating rate was a transition to a fixed one, and not a new exchange policy.
4. The discussions with the staff of the Fund regarding our exchange problem were started in Paris on September 9 when Mr. Towers and I saw the Managing Director, Mr. Gutt, and told him of the speculative inflow of funds and of the difficulties in fixing a new rate and put him on notice that the Canadian Government might decide to let the rate float. Gutt reminded us of the discussion regarding the Belgium exchange rate in September 1949 and of our opposition to the Fund approving the Belgian plan. We recalled that our opposition had been directly towards the Fund formally approving an action which was illegal under the Fund Agreement and that we had not argued that the Belgians should not follow this course of action if they thought it the best one for ahem and we said that for the same reason we would not propose (should the occasion arise) to request Fund approval in our own case. Gutt remarked that he did not see how the United States could oppose in view of their favorable attitude in the Belgian case and that he thought "it would be all right". In reply to his question whether the information was entirely for himself, I frst replied yes. On discussing this question again with Mr. Towers, however, we reached the conclusion that this should be withdrawn and I saw Gutt the next day and told him that we felt that it would not be right to limit his discretion in this way and at the same time I stressed the need for absolute security and expressed the hope that he would restrict the knowledge to the smallest number necessary. Gutt was clearly embarrassed at being given discretion in the matter and said that he could not trust Overby not to inform the U.S. Treasury but on the other hand he welcomed the opportunity to discuss the matter with Bernstein.
I phoned Gutt on Wednesday, September 27 to say that I would probably be asking him on Friday to summon a meeting of the Board for Saturday to discuss action along the lines of our Paris discussion. I indicated that I expected to arrive on Thursday night and see the Americans Friday afternoon. He phoned back a few hours later to say he was concerned at the shortness of the notice we were giving to the Americans and the British as he thought the discussions in the Fund would be easier if more time were given. I undertook to have the time arrangements reviewed in the light of his advice.
Gutt phoned me again on Thursday morning to say that Bernstein, who was with him, was greatly upset at the proposed action and we arranged to meet that night in Washington. I told Gutt he could have any members of his staff he wished present.
The Thursday night meeting was attended by Gutt, Bernstein, Horsefield and Gold. It soon became apparent that the other members of the staff thought we had informed the Fund of our intentions only on Wednesday and I was of course obliged to refer to the warning given Gutt in Paris on September 9. The staff members deplored our proposed action and felt that it was very injurious to the Fund, because it threatened a general breakdown of discipline. Bernstein also argued that if the action was justified then world conditions were in fact too unstable for the Fund to work and the best thing the staff members could do was go back and do something in their own countries. He also argued that the floating rate would be bad for Canada and would not solve our problem, which could only be met by direct controls over the inflow of capital. We were, in his opinion, doing great injury to the Fund without doing any lasting good to ourselves, merely for the sake of immediate relief from the inward pressure of speculative funds.
On Friday afternoon I attended, along with Keith of our Embassy, a meeting of the senior staff of the Fund where we went over the ground for about four hours. The staff were all hostile to the action and the cross examination fairly arduous. It was apparent that some staff members thought Bernstein's idea of direct control over capital inflow undesirable or impractical, while Bernstein and others thought that the only other alternative which came up for discussion, namely, the creation of public debt in Canada in any amount necessary to fnance the inflow of capital, was one which the Canadian Government should not be expected to follow. No member of the staff proposed that the exchange rate should be adjusted upwards to a new fixed level, though I believe that this view was in fact held by at least one senior officer of the Fund.
It was clear that the senior members of the staff were deeply resentful of what they regarded as the cavalier treatment of the Fund by Canada in giving so little notice and bringing the proposal before the Fund when it was virtually an accomplished fact, and I felt it necessary before leaving Washington to make sure (without I hope contributing to the difficulties between Gutt and Overby) that the main operating officials of the Fund knew that we had in fact given the Managing Director three weeks warning.
5. The Fund Board meeting took place on Saturday morning, September 30 and lasted, with some interruptions from 10 to 2. I began by outlining the position along the lines indicated in paragraph 1 above. There was then a recess to enable the members of the Board to read the staff paper "Canada: The Problem of Capital Imports", copy of which is attached.' This paper had to be put together in a very short time and it falls short of the normal quality of Fund documents.
After the recess I was invited to comment on the staff memorandum. I said that I had already informed the Canadian Government of the alternative courses of action (creation of public debt in required amounts and direct control of capital inflow) .which the staff recommended for consideration, and that these had in fact been reconsidered but did not carry the judgment of the Minister of Finance. The objections to continuing to finance the inflow of capital through creating public debt without a corresponding increase in productive assets were: (a) the complete uncertainty as to the amounts which might be involved, (b) the foreign exchange cost, (c) the budgetary cost and (d) the loss of control of domestic monetary conditions and the creation of inflationary pressures. I described the objections to the proposal for capital import control as being (a) technical the difficulty of distinguishing between speculative and productive inflows, the problems (including the problem of border control on Canadians) that would be created by the emergence of a premium on Canadian dollars in the unofficial market which would be the inevitable result of our instructing our banks not to buy U.S. dollars without reference to us, as we should be obliged to do, (b) substantive the close and pervasive connections between the Canadian and American economic systems which had operated to the advantage of both countries; the fact that we might continue to want U.S. assistance in helping develop our natural resources; and the difficulty of turning capital on and off like a tap or having an attitude friendly towards certain types of capital inflow and hostile to others, in view particularly of the difficulty referred to above in distinguishing between them, (c) psychological the general trend of governmental and public opinion in Canada is away from controls and it would be difficult to explain using powers given according to the preamble of the Foreign Exchange Control Act for the purpose of controlling capital exports, for the precisely opposite purpose.
Bernstein then made the case for the staff. He began by saying that the principle of the Fund was that exchange rates are not to be used as an instrument of domestic monetary policy and that had as a corollary that a country must find some other means of protecting itself from disturbing forces originating abroad. He did not think that what we were proposing would meet our problem. We wanted to avoid deliberate appreciation because of its affect on the balance of payments yet we would get appreciation to an unknown extent; we wanted to avoid using short term capital inflow to finance a current account deficit, yet we would be doing this to an unknown extent; we wanted to avoid accumulating the inflow of hot money, yet this would happen to an unknown extent. We must hope that a small appreciation would cut off the inflow and have but minor effects on the current account and that any residual dollar inflow could be dealt with by open market operations. These were uncertain hopes, and we should act on the principle that policy should be adequate to meet the problem that will arise under the most unfavorable assumptions. He agreed that parity should be rejected and thought the creation of public debt and offsetting open market operations unsuitable in view of the large magnitudes involved. Therefore he came to the recommendation regarding capital inflow, arguing that at least it was worth a try. In any case it was a dangerous policy for a government to allow the exchange rate to be primarily affected by capital movements of a speculative character particularly for Canada such a course meant continued uncertainty in exchange policy.
The members of the Board were then asked to express their opinion. Southard (U.S.A.) said the case for the Canadian action had been made out in a detailed and persuasive way. He had feared that a restoration of our exchange rate to parity with the U.S. might be in mind and he preferred the idea of letting the rate find its own level. Referring to Bernstein's remarks, he said that I had not claimed that our proposal would solve our problems, but if it didn't no doors would have been closed. His own hunch was that we could so manage the rate as to bring speculation under control. Even if we were driven to some form of capital import control in order to get back to a fixed rate, this would stand a much better chance of public acceptance after we had made this experiment. He shared my views regarding the desirability of avoiding interfering with the economic relationship between Canada and the U.S. in this way if at all possible.
Crick (U.K.) said that the Canadian Government had made out the case that their domestic monetary situation was being distorted by violent capital inflows and in his opinion we could not be expected to go on indefinitely buying all U.S. funds offered at the fixed rate. The floating rate proposed involved a degree of exchange instability which might produce difficulties for the U.K. but the U.K. Government was sure we had arrived at our decision after full consideration of all the difficulties involved including the difficulties to other countries. As to the alternatives proposed by the staff, open market operations to offset inflationary effects was feasible for small inflows but not for such massive ones; and the control of inward capital movements was an unknown field he could not conceive of the Canadian investment economy being so divorced from the U.S. investment economy. In the circumstances the U.K. Government would not question the decision the Canadian Government felt obliged to take.
Beyen (Netherlands) remarked that this was the third case of the kind the Fund had faced Belgium, which had not acted on the approval given, Mexico, and now Canada. He thought it no accident that the two countries which had been forced to let their rates float were the neighbors of the United States. He thought I had made out a strong case that this was a special situation and felt that the Canadian Government had to decide what responsibilities it was willing to take. For his part he did not think that capital import control was feasible in our situation nor that we should be expected to go on indefinitely creating public debt to finance additions to reserves.
Gutt intervened at this point to say that Beyen's remark that the Canadian Government had to decide what responsibilities it would take seemed to represent the negation of the Fund concept the Canadian Government had responsibilities under the Fund Agreement too. Beyen replied that this was true, but if the Canadian Government came to the conclusion that in order to cope with a serious problem it had to follow a certain course of action the Fund was not entitled to insist that alternative courses should be followed unless it could clearly demonstrate that they were preferable, and this the staff had failed to do.
Falaki (Egypt) found the Canadian exposé and replies convincing, de Lavergne (France) thought the proposal commendable, in view of the difficulties of the alternatives, Santaella (Venezuela) thought a strong case had been made out. Joshi (India) wondered whether this meant that any country faced with a similar situation could feel entitled to act in the same way.
6. Various proposals were put forward for the wording of the decision. Southard said he would like to use language similar to that which he had proposed and the Board had (on division) adopted in the Belgian case in September 1949. This would have described the Canadian action as "appropriate" and given the Board's formal approval. All the members of the Board who spoke except the U.K. and India said they would support this language. The U.K. suggested that the Fund should recognize the difficulties of the situation in its decision. The staff proposed language much less favorable than they had themselves put forward in the case of Belgium that the Fund should merely take note and request us to remain in consultation. I said that it was clear that the consensus of opinion in the Board would be to describe the Canadian action as appropriate and formally approve it, but that it seemed to us that the decision should be formulated in a way which would not divide the Board but which all could approve. We would therefore suggest that the language should follow the general line which the staff had proposed in the Belgian case. This suggestion was adopted and the decision was as follows: "1. The Government of Canada has informed the International Monetary Fund that in order to cope with large inflows of capital it has decided for the time being to allow the foreign exchange value of the Canadian dollar to fluctuate and therefore will not ensure that exchange transactions within its territories will be based on the par value established with the Fund.
2. The Fund recognizes the exigencies of the situation which have led Canada to the proposed plan and takes note of the intention of the Canadian Government to remain in consultation with the Fund and to re establish an effective par value as soon as circumstances warrant."