It's loonie - something's got to give

Lower interest rates? Peg the dollar to the U.S. buck? The government must consider its options

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The Gazette, Friday, November 9, 2007

Rule 1: The prime minister never talks about the dollar. And he never, ever, comments on the exchange rate with the U.S. dollar.

Thus, the prime minister said on Wednesday he never talks about the dollar, and then, extraordinarily, he commented on the flight of the loonie, which has blown through par with the greenback and traded as high as $1.10 on Wednesday morning before settling back around $1.07 yesterday.

"The appreciation we've seen is quite rapid by any standard, unprecedented in its rapidity by any standard," Stephen Harper said. "And I think that does require some reflection."

Well, that was coast-to-coast yesterday. The Globe and Mail online headline was typical: "Harper anxious about loonie's rapid surge."

The first part of his comment is a simple statement of fact. The loonie's rise has been "unprecedented in its rapidity by any standard." From 85 cents in January to $1.08 at the close on Wednesday, the dollar has appreciated 21 per cent against the greenback in 10 months. There has never been anything like it.

But Harper, though an economist, is not just some economist or analyst journalists call up for a quote. He's the prime minister, his words can move markets, and it's the second part of his comment that raised eyebrows: "I think that does require some reflection."

What kind of reflection? Does the prime minister think the Bank of Canada should lower interest rates to make the loonie less attractive? The PM and the governor of the Bank of Canada aren't supposed to discuss that with each other, the central bank being independent of the government, but this is one way of sending a message.

Or would Harper consider pegging the dollar, as opposed to the current regime of a floating exchange rate? John Diefenbaker tried this with a fixed rate of 92.5 cents, famously known as the Diefenbuck. The Liberals turned the Diefenbuck into a campaign handout. It was devastating.

Or do Harper and Dodge think the G7 finance ministers and central bankers should intervene to bolster the greenback by buying U.S. dollars on open markets?

The loonie is not alone in its rapid appreciation against the greenback. The euro is up by 11 per cent this year alone, and these appreciations have a significant impact on world trade, which is measured in U.S. dollars. Global merchandise trade of $11 trillion last year, and trade in services of $2 trillion, account for about one-third of the world's economic output.

The U.S. dollar has been weakening on fundamentals. George W. Bush has been trying to run a guns-and-butter economy, and the bills are coming due. By the time he leaves office in January 2009, the United States will have taken on another $2 trillion in debt. There is no virtuous cycle in the U.S. fiscal framework.

The sub-prime mortgage financial crisis in the U.S. housing market has sparked a shakeup in the financial services sector. Within the last week, Merrill Lynch and Citigroup have fired their CEOs. And the private equity deal market, which had been overheated, has cooled.

It isn't just Harper who's thinking out loud about the U.S. dollar.

Nicolas Sarkozy had quite a bit to say about it the other day, and a very interesting place in which to say it - in an address to a joint session of the U.S Congress.

"The dollar cannot remain solely the problem of others," Sarkozy said. "If we're not careful, monetary disarray could morph into economic war. We would all be its victims."

That's a remarkable statement, and even more remarkable for its setting. The president of France, before the United States Congress, was essentially proposing a rescue, or at least a stabilization strategy, to stop the further erosion of the U.S. dollar. No foreign leader has ever before said anything like it to such an audience in Washington.

But a co-ordinated intervention has happened before. Jim Baker, as U.S. treasury secretary, convened a summit meeting of G5 finance ministers in 1985, resulting in the Plaza Accord (the talks were at the Plaza Hotel in New York).

Back then, finance ministers agreed to depreciate the U.S. dollar against the Japanese yen and German deutschemark by intervening in currency markets. Over the next two years, the overvalued greenback fell by 50 per cent against the yen, bringing the U.S. current account and trade deficit into a more manageable state.

What can Harper and Dodge do about the loonie? Preaching for the manufacturing parish of Ontario, Premier Dalton McGuinty is calling for a rate cut to make the dollar less attractive and, thus, boost exports. But the Canadian economy, which needs no stimulation, is about to get some in the form of the further one-per-cent reduction to the GST. Dodge also has to be careful about adding any inflationary pressures to a full-employment economy where labour-market shortages are looming as a factor in inflation.

But something's gotta give. And soon.

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