Canada Hit by Overvalued Dollar

Some economists say inflation is licked and central bank should lower interest rates, dollar

THE Bank of Canada's high interest rate policy has kept the Canadian dollar overvalued, economists charge. This, they add, is hurting Canadian manufacturing and making the Canadian recession worse than the downturn in the United States."It is overvalued by 6 or 7 cents and should be worth 80 or 81 cents" in US money, says George Vasic, chief economist at the Toronto office of DRI/McGraw-Hill, an economic consulting firm. Canada's high interest rates attract foreign money, which keeps the Canadian dollar strong. Japanese investors, both private and institutional, are large holders of Canadian government bonds, drawn by interest rates of 10 and 11 percent. But the 87-cent dollar makes Canadian manufactured products more expensive in key foreign markets. John Crow, the governor of the Bank of Canada, has said repeatedly that his aim is crush inflation, and he uses the value of the Canadian currency to do it. Last week the central bank beat back a run on the Canadian dollar by intervening in the foreign exchange markets and avoided raising domestic interest rates further. The dollar had dropped almost a cent after allegations of influence peddling involving federal ministers and public officials. Money market traders and the financial press termed the central bank maneuver a victory. "Crow praised for keeping rates stable" read the headline on the business page of the Montreal Gazette. But for some economists it was a hollow victory. "Interest rates are still too high. This would have been a great opportunity to get the Canadian dollar down," says Douglas Peters, senior vice president and chief economist at the Toronto Dominion Bank. "As long as we have interest rates which are 2 to 3 percent higher than those in the United States, the dollar will remain strong and Canadian manufacturers will suffer." Meanwhile, economist Vasic says Mr. Crow and the Bank of Canada did the right thing. "He's on the right path. He wants to avoid a sharp rather than a gradual decline in the dollar." The idea behind keeping the dollar high is to keep inflation low. But many say that has already been achieved, that actual inflation in Canada is running at 2 percent. The number is higher due to the temporary effect of new tax increases - especially the 7 percent Goods and Services Tax applied since January of this year. "There is no evidence of inflation in the economic system, that is, anything to do with markets and demand" wrote Michael McCracken, chief economist at Informetica, an economics research firm in Ottawa. "On the contrary, what is apparent is deflation in the market-oriented segment of the economy." One measure of that deflation is a drop in the value of residential and commercial real estate from the highs of the late 1980s. That is especially true in Toronto, where house prices in some areas have dropped by as much as 40 percent from their highs. There is a glut of office space, with 3.5 million square feet empty. As a result, rents - once among the highest in North America - have fallen. Both money-market managers and economists are surprised that the Canadian dollar manages to stay at the level of 87 cents. They keep saying it can't last and not even the Bank of Canada will be able to keep it there. "Sooner or later foreign investors are going to smarten up. Currencies don't stay overvalued forever," Vasic says. As one example of the Canadian economy's weakness, he points to the phenomenon of cross-border shopping in which Canadians are pouring into the United States to buy goods which are cheaper - in part because of the overvalued Canadian dollar. And while projections are that the Canadian recession is over, there are worries the current upturn could be just a short blip. That happened in the 1981-82 recession. The Toronto Dominion Bank earlier this month said there is strong evidence that the Canadian economy is growing again after falling a 4.6 percent annual rate in the first quarter. But if the American economic rebound falters, then "the recovery in Canada would be placed in some jeopardy," the bank noted.

You've read  of  free articles. Subscribe to continue.
QR Code to Canada Hit by Overvalued Dollar
Read this article in
QR Code to Subscription page
Start your subscription today