Rising domestic inflation led to the establishment of the Prices and Incomes Commission in
1968 and to the introduction of a restrictive stance
on monetary policy. This occurred at a time when
the United States was pursuing expansionary
policies associated with the Vietnam War and with
a major domestic program of social spending.
Higher commodity prices and strong external
demand for Canadian exports of raw materials and
automobiles led to a sharp swing in Canada’s
current account balance, from a sizable deficit in
1969 to a large surplus. Combined with sizable
capital inflows associated with relatively more
attractive Canadian interest rates, this put upward
pressure on the Canadian dollar and on Canada’s
international reserves. The resulting inflow of
foreign exchange led to concerns that the
government’s anti-inflationary stance might be
compromised unless action was taken to adjust the
value of the Canadian dollar upwards.90
There
was also concern that rising foreign exchange
reserves would lead to expectations of a currency
revaluation, thereby encouraging speculative
short-term inflows into Canada.
On 31 May 1970, Finance Minister Edgar
Benson announced that
for the time being, the Canadian Exchange Fund will
cease purchasing sufficient U.S. dollars to keep the
exchange rate of the Canadian dollar in the market
from exceeding its par value of 92½ U.S. cents
by more than one per cent (Department of
Finance 1970).
Bank of Canada $50, 1975 series
This note was part of the fourth series issued by the Bank of Canada. This
multicoloured series incorporated new features to discourage counterfeiting.
While Canadian scenes still appeared on the backs (this note shows the
“Dome” formation of the RCMP Musical Ride), there was more emphasis
on commerce and industry. The Queen appeared on the $1, $2, and $20
notes. Others carried portraits of Canadian prime ministers.
90. Consumer prices were rising at about 4 to 5 per cent through 1969 and early 1970. Wage settlements were also rising, touching 9.1 per cent during the
first quarter of 1970.
7
2 A History of the Canadian Dollar
Canadian authorities also informed the IMF
of their decision to float the Canadian dollar and
of their intention to resume the fulfillment of their
obligations to the Fund as soon as circumstances
permitted. The Bank of Canada concurrently
lowered the Bank Rate from 7.5 per cent to 7 per
cent, an action aimed at making foreign borrowing
less attractive to Canadian residents and at
moderating the inflow of capital, which had been
supporting the dollar.
The government made the decision to float
the Canadian dollar reluctantly. But Benson
believed that there was little choice if the government was to bring inflation under control. He
hoped to restore a fixed exchange rate as soon as
possible but was concerned about a premature peg
at a rate that could not be defended.
As in 1950, other options were considered
but rejected. A defence of the existing par value
was untenable since it could require massive
foreign exchange intervention, which would be
difficult to finance without risking a monetary
expansion that would exacerbate existing
inflationary pressures. A new higher par value was
rejected, since it might invite further upward
speculative pressure, being seen by market participants as a first step rather than a once-and-for-all
change. Widening the fluctuation band around the
existing fixed rate from 2 per cent to 5 per cent
was rejected for the same reason (Beattie 1969).
The authorities also considered asking the United
States to reconsider Canada’s exemption from the
U.S. Interest Equalization Tax. Application of the
tax to Canadian residents would have raised the
cost of foreign borrowing and, hence, would have
dampened capital inflows. This, too, was rejected,
however, because of concerns that it would
negatively affect borrowing in the United States by
provincial governments (Lawson 1970a)
.
While recognizing the need for a significant
appreciation of the Canadian dollar, the Bank of
Canada saw merit in establishing a new par value
Image protected by copyright
at US$0.95 with a wider fluctuation band of
±2 per cent (Lawson 1970b). A new fix was seen
as being more internationally acceptable than a
temporary float, and since the lower intervention
limit of about US$0.9325 would have been the
same as the prevailing upper intervention limit,
such a peg would have been accepted by academics
who favoured a crawling peg. A new peg was also
viewed as desirable because it would preserve an
explicit government commitment to the exchange
rate consistent with its obligations to the IMF.
There was also some concern that a floating
exchange rate might “encourage, as it had in the
late 1950s, an unsatisfactory mix of financial
policies” (Lawson 1970a).
For its part, the IMF urged Canada to
establish a new par value. Fund management was
concerned about the vagueness of Canada’s
commitment to return to a fixed exchange rate,
fearing that the float would become permanent as
it had during the 1950s. The IMF also feared that
Canada’s action would increase uncertainty within
the international financial system and would have
broader negative repercussions for the Bretton
Woods system, which was already under considerable pressure. Canadian authorities declined to set
a new fix, emphasizing the importance of retaining
adequate control of domestic demand for the
continuing fight against inflation.