The jig is up for our cheap dollar
David Frum  
National Post    Dec. 23,2000
It's worse than even Stockwell Day says. On Thursday, the Opposition leader published on this page a warning that President-elect Bush's tax-cut plan threatens to make Canada's high tax rates even more dangerous to our national prosperity than they already are: "An ambitious tax cut, on top of already low American tax rates, can only increase the U.S.'s competitive edge over Canada and exacerbate the brain drain." But the incoming Bush administration will increase the pressure on the Chrétien government's economic strategy in an even more ominous way: by taking a tougher line on the value of our dollar.

It's not well enough understood how central the devaluation of the dollar has been to the Chrétien government's economic policy. Tax increases and spending cuts make the headlines, but the real core of the policy was devaluation.

When the Chrétien government came to power, it faced two severe problems: (1) a debt burden so heavy that many speculated the federal government might be forced to default and (2) an extremely weak economy -- high unemployment, declining real incomes, slow economic growth. The most obvious solution to these problems was to reduce the deficit by cutting government spending and to spur growth by cutting taxes. That solution was politically unacceptable to the Liberals, for all kinds of reasons.

Instead, the Liberals arrived at a much more complicated and ingenious answer: a cheap-dollar policy. The cheap dollar promised to do five important things for the government.

First, it spurred economic activity. A low dollar reduces the real value of everybody's wages, encouraging foreigners to invest here and to buy from us.

Second, it reduced the burden of the government's debt. By accepting an endlessly declining dollar, the government was able to achieve lower interest rates, diminishing the amount it paid its creditors.

Third, it forced down Canadian living standards. Because the dollars they earned bought less on international markets, individual Canadians consumed less. Between 1993 and today, the value of the Canadian dollar has tumbled by close to 20% against the U.S. dollar. Most Canadians' nominal incomes have risen nowhere near so much as that. Which means most Canadians can afford to buy 20% less as compared to equally skilled Americans than they could in 1993.

Fourth, by squeezing private consumption, it helped maintain government consumption. By stimulating production with wage cuts rather than tax cuts, the low dollar ensures the burden of the shrinking national income is redirected away from the public sector to the private sector.

Fifth and last, the cheap dollar did all this in a way that most Canadians didn't perceive right away, didn't clearly understand and thus did not blame the government for.

The policy has achieved almost everything the government could have hoped for. But it had and has one huge point of vulnerability: It could not have been carried on without the tacit consent of the U.S. government. Canada earns its living as a supplier to U.S. industry. We are not, despite our self-image, much of a natural resources producer anymore. Only one of our top five exports is the product of the land: pulp and paper. We export auto parts, office equipment, aircraft components, high-tech machinery and so on. And when our dollar tumbles, we artificially undercut the American workers and companies who compete with us. From an American point of view, that looks like an unfair trade practice, and ordinarily an American government might be expected to defend its people against the practice by, for example, imposing some kind of protective barrier.

The Clinton administration chose not to do that. It let Canada's trade surplus rocket up to nearly $35 billion in 1999 without a murmur. The Americans could be so complaisant because their own economy was working at full capacity. Who cared about Canadian workers undercutting Americans when U.S. unemployment was exploring amazing new subterranean lows? But they also had a strategic concern. In 1998, in fact, a whole string of financially stressed countries plunged into crisis: Malaysia, Indonesia, South Korea, Russia, Brazil, Mexico, even Japan. Nobody could be sure America's nearest neighbour and largest trading partner wouldn't go over the cliff too. So they looked the other way as we devalued and devalued and devalued again.

Will a Bush administration be equally easygoing? There are good reasons to guess it will not. The U.S. economy is slowing. Unemployment is likely to rise and with it, political pressure to do something about Canada's big surplus. After the Chrétien government's amazing display of Democratic partisanship in the election -- Ambassador Raymond Chrétien gave a speech in which he said Canada would prefer a Gore win -- the Bush administration will be in no mood to dispense special favours. And the big surpluses Canada has piled up over the past three years make it less credible for the Canadian government to say devaluation is the only feasible way to stimulate our economy. The Bush people will naturally want to know why we don't cut taxes instead and consume our production at home rather than shipping it all southward to put Akron tiremakers out of work.

Fortunately, our free trade agreement limits the power of the Americans to impose sanctions on our exports. The treaty Jean Chrétien opposed may help preserve his pet economic policy. And of course, there are always deals to be made. Mr. Bush wants to develop a continent-wide energy policy. Mr. Chrétien might be able to trade access to Canada's natural gas for permission to go on devaluing.

Of course, a trade like that would constitute a galling surrender of everything Canadian statists like Mr. Chrétien most treasure. But in a roundabout way, it would be poetically just: Mr. Chrétien has kept power through policies that began by beggaring Canadians -- now they are ending by humiliating him.