Will the cheaper Canadian dollar actually help troubled Canada to regain its industrial competitiveness, stem its deteriorating international balance and gets its stagnant economy moving again? Or will it prove to be only a temporary advantage that is squandered in a new bout of inflation, leaving the country back where it started, only with a debased currency?
These are the questions preoccupying Canadian government officials and businessmen as they examine the year-long plunge of the Canadian dollar on the foreign exchange markets, a plunge that has been deeper than many anticipated.
Last Monday, the Canadian dollar dipped to 89.86 cents against the U.S. dollar, a 40-year low, but it bounced back to hover above the psychologically significant 90-cent level as the week ended.
Just 12 months ago, by comparison, the Canadian dollar was valued at $1.03, a drop against the U.S. dollar since then of about 13 per cent. And because the U.S. dollar has itself been a notable slider in the currency markets over the year, a comparison of the Canadian dollar with the Japanese yen or German mark shows an effective devaluation of about 25 per cent.
Predictions on the near-term trend in the Canadian dollar vary from those that indicate a further drop - perhaps to as low as 85 cents - is still to come, and those that say the markets have carried the currency too low and a bounce-back to around a 92- or 93-cent level is probable.
Toward week's end, the Canadian government took the first overt step to bolster confidence in its currency against renewed speculative attacks.
Finance Minister Jean Chretien announced that the Bank of Canada has arranged a standby credit of $1.5 billion in U.S. dollars through Canadian charter banks in case the money is needed to shore up the Canadian dollar in the exchange markets. This amount would be on top of the approximately $1.3 billion in official reserves the country's central bank has at its disposal.
"It is being arranged to permit the exchange fund account to replenish its holdings of U.S. dollars if and when circumstances require," Chretien said.
Up to now, the Canadian government has said it is permitting the dollar to float freely, with intervention only to maintain orderly markets. The latest move was seen as having mainly a psychological impact, underlining the government's willingness to stand by the Canadian dollar at around the 90-cent level.
Over the longer term, the direction of the Canadian dollar will depend on the course of Canada's economy. It has languished during the past year, teetering between recession and a very mild advance. Real growth has been barely 2 per cent, while inflation and unemployment are both above 8 per cent.
The devaluation theoretically should give this country's goods a competitive boost, lowering effective export prices by about 10 per cent. But some companies seem inclined to reap the advantage of the devaluation in higher profits for good sold abroad rather than to cut prices in order to lift market share.
At the same time, because imports constitue 25 per cent of the Canadian consumer price index, the higher cost of imports as a result of devaluation is expected to add about 2 per cent to the inflation rate next year on top of an underlying pressure on prices of about 6 per cent.
The Liberal Party government of Prime Minister Pierre Trudeau meanwhile recently announced a phased end to this country's two-year-old system of wage and price controls beginning next April 14. Decontrol itself poses the threat of a wage and price explosion, though economists are hoping that the comparatively weak Canadian economy will provide a discipline that cools desires by unions and businessmen to make up for lost ground.
The trick the Trudeau government must pull off over the next year is to reap the advantage of the Canadian dollar devaluation without allowing a resurgence in inflation to negate the exchange adjustment, and to prevent a loss of confidence in the Canadian economy by foreign investors.
To achieve this goal, the government is trying to bring down wage inflation even as decontrol looms. Chretien, in a recent major economic policy address to the Canadian parliament, set a 6 per cent wage and salary guideline for the third year of the country's economic controls program - down from 8 per cent in 1977 - even as he announced the phaseout of the controversial policy.
"Barring unforeseen events, the rate of inflation will come down below 6 per cent next year," Chretien said. "So the lower guidelines will not lead to a fall in real incomes." He aslo predicted that Canada's output of goods and services will advance by 5 per cent next year in real terms, close to the country's long-term potential.
But few forecasters think the economy will prove that strong, that inflation will drop this low in 1978, or that there will be much of a dent made in unemployment. And they suspect that the Trudeau government - though facing possible elections next spring - is indeed expecting citizens to swallow a temporary drop in real income if they believe the country's inflation rate is genuinely being wound down.
Robert H. MacIntosh, executive vice president of the Bank of Nova Scotia and one of the few members of the financial community who correctly predicted the Canadian dollar would drop this low, says "the forces which have put it down to 90 cents are not fully worked through."
"We've been very noncompetitive in the last three years," said MacIntosh. "We allowed wages and salaries to get 10 to 15 per cent above where they should be in relation to the U.S. You can only correct that by having a real cut in wages and salaries or by an exchange rate adjustment or a combination of the two."
One major reason given for the Canadian dollar's slide has been the continuing political turmoil in Canada, set off a year when the Separatist Party gained power in Quebec Province. The surprise victory of Premier Rene Levesque's pro-French PartiQuebecois did in fact trigger the start of the Canadian dollar's decline. And now that the seriousness of Levesque's separatist intentions are fully acknowledged, the question poses profound political uncertainty for the country's government until it is resolved, which could be several years at the least, though its effects are hard to quantify.
Levesque's recent move to take over the Adbestos Corp. from its U.S. owner, General Dynamics Corp., either by acquistion or, if necessary, by expropriation, did not come as a surprise. But it was viewed as a further deterrent to investment confidence in Canada and was blamed for some of the Canadian dollar's latest drop.
However, analysts say the major reason for the Canadian dollars overall decline lines in the country's tepid economic performance and its large international payments deficit, as well as to some technical factors that inflated the currency to $1.03 last year, an artificially high level to begin with.
In addition, a significant narrowing of the short-term interest rate differential between Canada and the U.S. has slowed the movement of funds to Canada that tended to keep the Canadian currency relatively stronger.
While Canada managed to avoid the sharp downturn in economic activity that took place in the U.S. and the other major industrialized economies in 1974 and 1975, it also has avoided any vigorous economic rebound. The Trudeau government recently introduced a mild stimulus program before Parliament, which would include some inducement for business to invest and provide a one-shot individual tax cut averaging $100 that would be injected into the economy early in 1978 and, it is hoped, would kick off a jump in consumer spending and a broader economic expansion.
But the government has little ability to maneuver in its fiscal policy because it is hampered by the nearly $9 billion budget deficit that is already being run this year - proportionate to a $100 billion budget deficit in the U.S.
And on the day the stimulus program was outlined, Inco, Ltd., the world's largest nickel producer, made the surprise announcement that it was laying off 3,400 worker sin Ontario and Manitoba, a blow to the fragile economic outlook. The income move could take several hundred million dollars out of the consumer spending stream alone, and there are fears of similar layoffs still to came in other mining industries.
Canada meanwhile is running a deficit on its current account this year estimated at about $4.5 billion. This is more than twice as large in proportion to its gross national product as the $73 billion red-ink total the U.S. is amassing in its international transactions this year.
Actually, in terms of merchandise trade, Canada is running a $2 billion surplus this year, in contrast to the U.S. where the trade deficit could top $30 billion. The reason is that Canada realies on large resource exports of minerals, lumber and agricultural commodities. Even in the face of this year's weak international markets, these exports are more than enough to cover a $12 billion deficit on manufactured goods where Canada has grown increasingly uncompetitive.
And this merchandise surplus is more than offset by a massive $7 billion deficit in the country's services balance - outflows for foreign travel, transportation and interest payments on foreign debts, all of which are worsened by the devaluation.
In the face of the Canadian dollar decline, the authorities here appear to have maintained their equanimity, avoiding large-scale intervention to defend the currency, with the move at the end of last week for a standby credit marking the slight departure.
"The policies we are following of getting our costs down and our employment up are directed at our fundamental problems," Chretien said recently on the exchange rate question. "With such policies, our balance of payments will improve. We have operated in the market to maintain orderly conditions." He acknowledged some loss of reserves, but said Canada has substantial reserves remaining and "the capacity to supplement them substantially should the need arrive."
He also ruled out any imposition of exchange controls.
G.K. Bouey, governor of the Bank of Canada, declined during an interview to give his view of whether 90 U.S. cents was a comfortable or appropriate level at which the Canadian dollar should stabilize.
He did note that it has "gone quite a long way in adjusting," and admitted that the most recent October decline came as somewhat of a surprise to the authorities. He attributed this drop more to a new round of negative articles on the Canadian situation in the U.S. press then to any new deterioration in fundamental conditions.
"It looks to me as if the Canadian economy is expanding again, though slowly," he said, and predicted that "the bulk of the improvement" in trade flows resulting from the exchange adjustment "is still to take place."
On the negative side, Bouey said "business confidence is all important, and business confidence is not very good."
The attitude of businessmen in Canada is similar to that of their U.S. counterparts. They have shown little zest for capital expansion and feel that a weak economy and uncertainty fomented by government policies are the main reasons.
"For two years we've been wallowing in a very conflicting economic environment," said J.A. Armstrong, chairman of Imperial Oil, Ltd., Canada's largest oil company, which is controlled by the U.S. Exxon Corp. "We've had controls, very little growth in gross national product, high unemployment, high inflation - and it's very difficult to see where the economy is moving," added Armstrong in comments typical of businessmen's sentiments.
Despite the blow from the Inco layoffs, there are some recent tentative signs that the Canadian economy is beginning to move forward. With savings rates extremely high, there seems to finally be some pickup in consumer spending, and a recent report on domestic production shows some encouraging signs.
A few economists like MacIntosh think Canada will be hard pressed to show real growth next year much beyond this year's two per cent.
Bur Robert Rene de Cotret, president of the Conference Board in Canada, sees 5 per cent real growth as possible in 1978. Douglas Peters, chief economist and vice president for the Toronto Dominion Bank, puts the target closer to 4.6 per cent. And Judith Maxwell, director of policy analysis for the C.D. Howe Research Institute in Montreal, predicts a 4 per cent advance.
All caution, however, that Canada's prospects are closely tied to the U.S. economy, which is the market for 70 per cent of the country's exports and which has lately seen its own growth rate slow to below 4 per cent. "If the U.S. goes into a recession, we're in trouble, too," said Peters.
The hope, however, is that the U.S. recovery will remain intact, and that Canada gradually can pick up its own pace of economic activity - aided by a cheaper Canadian dollar - while whittling down inflation. It's a somewhat risky strategy, and the Trudeau government will be under pressure to change its gain plan throughout next year if things don't improve.
But the optimists say that if this course is successful, 1979 could be boom year, led by massive energy investment projects on the drawing board such as the $10 billion gas pipeline project recently approved by President Carter and Prime Minister Trudeau.
But until 1979, the Canadian economy must walk a taut and narrow tightrope with many slips possible along the way.