Fighting To Slay Two Dragons At Once

Bank of Canada Governor Gordon Thiessen recently confessed that his dream was "to give boring speeches in calm times." He's definitely out of luck, as Canada's financial markets are anything but calm these days. Despite hiking interest rates almost weekly since November, Thiessen has been unable to prevent investors from dumping their Canadian dollars. As of Jan. 24, the Canadian dollar hovered just above 70 cents U.S. (chart). That's down from 74 cents last fall and just a penny above the all-time low in 1986.

The slide isn't as bad as the Mexican peso's, but it has perilous implications for the economy. The crisis could sharpen in coming weeks as investors anticipate two key tests for the Liberal government of Prime Minister Jean Chretien. The first is whether the government's budget, to be presented in late February, will credibly attack Canada's debt, which is 100% of gross domestic product, among the worst in the industrial world. The second is whether Chretien can counter the separatism of Quebec Premier Jacques Parizeau, who kicks off his pro-independence campaign in mid-February. If Parizeau quickly gathers popular support, the markets may panic at the prospect of a Canada more preoccupied with separatism than with straightening mut its financial affairs.

"REAL SQUEAKER." To restore confidence, Chretien needs to score convincing victories on both fronts. If he does, "the dollar will be headed sharply upward," predicts John McCallum, chief economist at the Royal Bank of Canada. He figures that the Canadian dollar is actually worth about 80 cents U.S. But even Thiessen concedes that international investors, who hold over 40% of Canada's debt, have good reason to doubt Chretien's recent pledges of fiscal rectitude. He notes that previous Canadian governments failed to meet deficit targets.

At the same time, the Quebec referendum is "shaping up as a real squeaker," worries Brian Neysmith, President of the Montreal-based Canadian Bond Rating Service. A Parizeau victory could have an "unprecedented negative impact" on the dollar, he says.

The crisis threatens a recovery that boosted the economy some 4.2% last year, while inflation remained under 1%. Exports surged as the currency sagged. "The weak dollar has helped us in the short term," says Peter W. Currie, chief financial officer of Northern Telecom Ltd., which last year garnered 87% of its sales outside Canada. "But now," he worries, "it's becoming a definite negative." If rates--like the prime, now at 9.25%--keep climbing to shore up the dollar, then a recession could return next year. That would quash hopes of further drops in unemployment, now at 9.6%. In a stark reminder of the persistent job problem, 26,000 Canadians recently lined up to apply for work at General Motors' plant in Oshawa, Ont., even though the company had no immediate openings.

TAX HIKES? In order to take pressure off the dollar, Finance Minister Paul Martin is pledging a budget that would trim Canada's deficit to $17.5 billion, down from the $28 billion projected for the current fiscal year, ending in March. Such cuts are needed to offset the billions the government must pay in higher interest payments. Martin is looking at such areas as higher education, foreign aid, and agriculture to achieve the promised reductions. Those "goals will be met," Chretien vowed in a recent press conference.

But Chretien also concedes it just keeps getting tougher to cut spending and still "maintain the level of dignity and decency in this country." Such talk suggests that Chretien may resort to tax increases to narrow the budget gap, a tactic Canadian business leaders vehemently oppose.

There's also growing concern about Quebec. Chretien continues to pooh-pooh the separatist threat. But Parizeau, more disciplined since his narrow election to premier last fall, is determined to convince skeptical Quebeckers that independence can be managed. His strategy is to have the Quebec National Assembly draft a detailed blueprint for an independent Quebec, which voters would then approve in a referendum to be held as early as June. Suppmrt for Parizeau's Parti Quebecois has soared to over 50%, up from 44% last fall.

Most experts still expect Parizeau to lose the referendum. But even a close defeat would be a public relations coup for Parizeau. He then could claim a mandate to continue his crusade for months, if not years, thus guaranteeing the kind of national turmoil that the financial markets dread. Appeasing those markets in the coming months will take all the acumen and discipline Canada's leaders can muster.

By William C. Symonds in Toronto

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