Article

Canada’s Capital Inflow, 1946–53

Author(s):
International Monetary Fund. Research Dept.
Published Date:
January 1955
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SINCE the end of World War II, Canada has undergone a period of rapid economic development which has been accompanied by a rising inflow of private long-term capital from the United States. Over much of the period, and especially since the introduction of a fluctuating exchange rate in October 1950, there have also been important movements of short-term funds. Canadian experience with both types of foreign capital has been extensive enough to be of general interest as an illustration of the conditions which attract foreign capital, and of the impact of that capital on the domestic economy as well as on the payments position and exchange rate policy.

Between 1946 and 1953 the net inflow of private capital into Canada amounted to about $1,540 million, plus over $1,200 million in reinvested profits.1 Virtually the whole of these receipts originated in the United States, and the gross value of U.S. long-term holdings rose from $5,000 million in 1946 to $8,600 million in 1953. Holdings by overseas countries rose meanwhile by $500 million, to $2,600 million, entirely as a result of reinvested profits.

Long-term receipts from the United States, apart from reinvested profits, consisted principally of direct investment by U.S. business firms in affiliated Canadian companies or branches. Before 1951 direct investment receipts were largely offset by net redemptions of portfolio securities; since that year, however, there have also been important net receipts from the proceeds of new issues. The wartime inflow of short-term funds came to an end in 1946, and transactions thereafter were light through 1949. Since then, short-term capital movements have been more volatile, first reinforcing and then neutralizing the long-term flow. In 1950, the expectation of an appreciation of the Canadian dollar led to an inflow of $770 million. The movement reversed itself after the middle of 1951, and in 1952 there was an outflow ($600 million), which continued, though on a much reduced scale, through 1953.

The postwar inflow of long-term capital has coincided, like capital receipts in earlier years, with a period of heavy domestic investment. However, external receipts of new long-term capital were equivalent to only 12 per cent of net domestic investment between 1948 and 1953, against 25 per cent in 1928–30. In further contrast to earlier periods, the bulk of the postwar inflow has consisted of equity capital. Over half of the postwar receipts of direct investment capital from the United States have entered the extractive industries (oil and metal mining), in contrast to earlier concentrations in manufacturing industry and commercial and financial services. This has been especially true since 1951. Since metals, together with pulp and paper, are among the principal export industries, it appears that the recent inflow has been stimulated largely by the increased demand for Canadian exports in the United States. New issues of Canadian securities in the United States have consisted almost entirely of bonds, issued by provincial and municipal governments. The swing from net redemptions through 1950 to net borrowing in the last three years is the result of rising capital requirements in Canada, the relative rise in Canadian interest rates, and, to some extent, of changes in the rate of exchange.

Short-term capital movements (transactions in outstanding Canadian securities, commercial credit, and changes in bank balances) have responded principally to exchange rate movements and to shifts in relative interest rates in Canada and the United States. These forces largely accounted for the inflows of 1941–46 and 1950 and for the various inward and outward movements since the inception of the fluctuating rate in October 1950.

Canada’s success in attracting private capital from the United States appears to have been due to both the existence of profitable investment opportunities in the expanding domestic and export markets and the absence of obstacles to the international movement of funds. These conditions have resulted in a level of corporate profits after tax slightly higher than in the United States. Also, bond yields are typically as much as 1 per cent higher than in the United States. External capital is not subject to discriminatory regulation or taxation, and both profits and capital may be withdrawn without restriction. In addition, policies directed to the avoidance of inflation and of direct controls over the domestic economy have probably helped to attract external funds.

Over the past 25 years the capital and current account balances have tended to reinforce one another during periods of fixed exchange rates, and to offset one another during periods of fluctuating rates. These trends have been due largely to short-term capital movements. Throughout there has been a tendency for periods of long-term receipts to coincide with current account deficits resulting from a high rate of domestic investment. This illustrates the effects of a long-term inflow in supplementing the internal resources of the economy and in permitting a higher rate of investment than would otherwise have been possible.

In addition to financing a series of current account deficits, the postwar inflow has strengthened the structure of the current account, since it has been concentrated in the export and import-saving industries. Moreover, although investment income payments have risen as a result of the postwar capital inflow, the burden of these payments has fallen—from 17 per cent of current receipts in 1927–29 to 7 per cent in 1952 and 1953.

The relation of short-term capital movements to the current account balance has varied with the exchange rate system. In 1950, prior to the inception of the fluctuating rate, a strengthening of the payments position as a result of long-term capital receipts and increased exports to the United States led to a speculative inflow of short-term funds, which was the proximate cause of the decision to suspend support of the fixed exchange rate. Since then, the rate of exchange has tended to move in response to the balance on current and long-term capital account; these movements of the rate have in turn evoked short-term capital movements in the opposite direction, which have worked, in the absence of official intervention in the market, to stabilize the rate within a relatively narrow range. These equilibrating movements, however, have depended largely on the confidence of investors in the stability of the economy and hence in the long-run appropriateness of the exchange rate. Over the past three years, market opinion appears to have changed so as to accept the suitability of a somewhat higher rate than formerly.

While the capital inflow has served to accelerate the development of the Canadian economy, it has at times intensified the problems of maintaining internal monetary stability in the face of inflationary pressures. This was particularly the case during the period of fixed exchange rates, when capital and current account surpluses tended to coincide. In those years, the effects of movements in the balance of external transactions were met largely by insulating the credit base from the effects of movements in the international reserves and by the achievement of budgetary surpluses. In 1950, however, it was felt that the inflationary effects of the capital inflow could no longer be restrained by these means, and it was decided to meet the problem by permitting the exchange rate to fluctuate. Since then the monetary position has been substantially insulated from the pressure of external transactions.

The Cycle of Capital Movements

Canadian economic development since the end of World War II has been based on a high rate of domestic capital formation. New domestic investment in fixed capital, net of replacement needs, amounted to about $14,000 million in the seven years 1946–52, the annual rate rising from 8 per cent of net national income in 1946 to 17 per cent in 1952. In the same period there was a net inflow of private external capital of about $1,210 million; domestic development was aided also by the reinvestment of profits by nonresident concerns of considerably more than $1,000 million. The contribution of foreign capital under both headings was thus equivalent to about 17 per cent of net domestic fixed capital formation.

The inflow of private capital into Canada since the war is a resumption of a long established movement. Over the past 50 years there has been a large inflow into Canada of foreign capital, which has entered the country in a series of waves. The first of these was from 1900 to 1918, with a distinct peak between 1908 and 1914; a second wave came after World War I, from 1920 to 1924; and a third from 1929 to 1932. From 1933 through 1940 there was a consistent repatriation of capital, principally through the redemption of Canadian securities and the liquidation of other long-term assets, which was apparently attributable to the stagnation and lack of confidence that characterized those years. Private capital imports were resumed during 1941 and continued through 1945, principally in the form of purchases of Canadian bonds.

Apart from the inflow during World War II, all of these successive periods of capital receipts, including the present phase, have exhibited broadly similar characteristics. As might be expected, they have coincided fairly closely with periods of high domestic capital formation and with periods of current account deficits.2 The most recent inflow, beginning about 1948, differs from its predecessors in size and in the composition and destination of the funds; it is also different inasmuch as there have been important fluctuations in short-term capital receipts.

All of the recent inflow of new capital has entered Canada from the United States; and it has comprised about 40 per cent of the net outflow of U.S. long-term capital to all areas. On balance the sterling area and other countries have in recent years withdrawn funds from Canada (Table 1).

Table 1.Net Private Capital Receipts by Canada, 1946–531(In millions of Canadian dollars)
Source219461947194819491950195119521953Total
United States88–16411164961554–782581,794
Sterling area3–126–3311–40–7574–7453–210
Other countries2–621–33315–919–46
Total–36–259123–9917633–1613301,538

No sign indicates net inflow; minus sign indicates net outflow.

By country of transmission. The statistics do not distinguish the country of original ownership; thus the figures for the United States include any non-U.S.-owned funds transmitted from the United States to Canada.

Excludes changes in sterling area holdings of Canadian dollars and in Canadian-held sterling balances.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1958 (Ottawa, Canada).

No sign indicates net inflow; minus sign indicates net outflow.

By country of transmission. The statistics do not distinguish the country of original ownership; thus the figures for the United States include any non-U.S.-owned funds transmitted from the United States to Canada.

Excludes changes in sterling area holdings of Canadian dollars and in Canadian-held sterling balances.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1958 (Ottawa, Canada).

The United States has been almost the sole external source of new capital for Canadian development since World War I. Up to 1914 the United Kingdom provided more than two thirds of the external capital entering Canada, but this movement was not resumed after 1918. Since 1927 there has been an almost continuous repatriation of capital to the United Kingdom; this was accelerated during World War II by the exigencies of war finance. There was a small volume of investment by other European countries during the late 1920’s, and another inflow, probably of refugee capital, during the late 1930’s. At no time, however, have countries other than the United States and the United Kingdom been an important source of capital for Canada (Chart 1).

Chart 1.Net Private Capital Receipts by Canada, 1927–63

(In millions of Canadian dollars)

1 Data for “other countries” for 1940–45 are included with United States.

2 Excludes changes in sterling area holdings of Canadian dollars and in Canadian-held sterling balances. Data are for British Commonwealth, 1938–45, and for sterling area, 1946–53.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments: 1926 to 1948; 1946–52; and 1953 (Ottawa, Canada).

Similar results are shown by an examination of the growth in value of outstanding investments, which takes account of reinvested profits as well as of new capital. During the eight years, 1946 through 1953, U.S. holdings increased in value by approximately $3,600 million, compared with an increase of about $500 million in the gross book value of U.K. and other long-term holdings in Canada. These developments are reflected in Chart 2, which brings out clearly the previous decline in U.K. holdings. The U.K. share of private external holdings in Canada declined from 44 per cent in 1926 to 18 per cent in 1953, while that of the United States rose from 53 to 77 per cent.3

Chart 2.Holdings of Canadian Assets by Residents of Other Countries, and Canadian Holdings in Other Countries, Selected Years, 1926–531

(In millions of Canadian dollars)

1 Long-term investments. Includes Newfoundland beginning with 1949. The data for 1953 are preliminary.

2 Excludes official reserves and investments by insurance companies and banks.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments: 1926 to 1948; 1946–52; and 1953 (Ottawa, Canada).

Canadian Exports of Capital

Simultaneously with the postwar inflow of capital into Canada there have been external investments by Canadians which, while small in comparison with Canadian receipts, are by no means unimportant in absolute terms. Between 1945 and 1953 the value of private Canadian holdings of long-term external assets increased by $860 million, from $1,341 million to $2,200 million.4

The greater part of this increase took the form of investment in the United States, which rose from $864 million in 1945 to $1,505 million in 1952. Most of the increase was in direct investments, which more than doubled in value (from $455 million to $966 million), mainly as a result of the reinvestment of profits by Canadian-owned concerns; portfolio holdings, which had amounted to $409 million in 1945, rose also, by $130 million.

Private Canadian holdings in the United Kingdom have remained steady at around $100 million since the end of the war, but there has been an increase of about $40 million, to $138 million, in investments in the outer sterling area. In both cases an increase in direct investments was partly offset by a liquidation of portfolio holdings. As regards the rest of the world, Canada appears on private account to be a net creditor in Latin America and a net debtor in Europe. Direct investments in these areas fell by $30 million between 1945 and 1952, as a result of the sale to U.S. investors of a large oil holding in Latin America, but portfolio holdings increased and the total value of Canadian holdings in these areas rose by $77 million, to $359 million.

Although Canadian external investment since the war has been appreciable in absolute terms, and certain individual projects have been of considerable importance, capital exports have remained small in comparison with domestic investment and the capital inflow. This has been in spite of the fact that Canada has a per capita income second only to that of the United States and a rate of private saving nearly as high.5 It is true that Canadian development is being financed increasingly out of domestic savings, which is a normal and almost predictable development as income per capita rises. So far, however, there have been no outward signs of a change from net borrower to net lender status.

The reasons appear to lie mainly in the greater attractiveness of investment opportunities in Canada itself, which have retained domestic capital in Canada at the same time that they have attracted external funds. In some instances, mainly in manufacturing industry, market opportunities in the United States have been attractive enough to overcome the pull of domestic development and to lead to direct investments by individual Canadian firms; there has been some repatriation of funds, even from the United States, during recent years, but the value of Canadian holdings has on balance increased since the end of World War II. Outside the United States such opportunities appear to have been comparatively few, and Canadians have presumably been deterred by the same obstacles which have affected U.S. investors.

Composition and Timing of U.S. Capital Flow

Long-term investment of U.S. funds in Canada has taken the form of direct investment in affiliated companies, and of portfolio purchases of new Canadian security issues; Chart 3 and Table 2 suggest that the fluctuations in these forms of investment have been more or less parallel. Short-term capital movements are interpreted as including transactions in outstanding securities and “other” capital movements.6 The available statistics suggest that these two types of capital movement have fluctuated under the impact of different influences.

Chart 3.Composition of U.S. Capital Inflow to Canada, 1927–53

(In millions of Canadian dollars)

1 For 1938–45, includes all other non-Commonwealth countries.

2 For 1938–45, direct investment is included with other capital.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments: 1926 to 1948; 1946–52; and 1953 (Ottawa, Canada).

Table 2.Capital Movements Between the United States and Canada, 1046–631(In millions of Canadian dollars)
19461947194819491950195119521953Total
Direct investments386861842002703193301,360
New issues (net)–242–21864–31–63246240107102
Trade in outstanding securities262–5–44443038–06–60610
Other capital (net)35–5–13–463386–495–166–346
Canadian investment in U.S–56131346–6–47–43–22
New capital inflow (net)88–16411164961664–782681,704

No sign indicates inflow to Canada; minus sign indicates outflow from Canada.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

No sign indicates inflow to Canada; minus sign indicates outflow from Canada.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

The long-term component of the postwar capital flow from the United States has been somewhat more stable than the short-term. During and immediately after the war there was an efflux of long-term funds, as receipts for direct investment failed to cover the outflow for net redemptions of Canadian securities. Since 1948, however, long-term capital has been entering in increasing volume. Direct investments rose rapidly from $61 million in 1948 to $200 million in 1950 and to $330 million in 1952. New issues of Canadian securities in the United States, which exceeded retirements for a short time in 1948, revived strongly in 1951–53 and raised the total long-term inflow to more than $500 million in each of the last three years.

In contrast, short-term capital movements have fluctuated more widely. U.S. purchases of outstanding Canadian securities were heavy during the war but fell away between 1946 and 1949. In 1950 they rose precipitously to about 1770 million, largely as a result of expectations of an appreciation of the exchange rate. During 1951 the various types of short-term transaction were largely offsetting, an inflow during the first half of the year being nearly matched by an outflow in the second half. Subsequently, as the exchange rate rose in 1952, there was a heavy outflow of short-term capital of almost $600 million. These movements added importantly to the steady inflow of long-term capital in 1950, but completely neutralized it in 1952.

From this analysis it is evident that the over-all capital outflow in 1952 did not mean that the postwar capital inflow from the United States had run its course and reversed itself. In fact, during 1953 net receipts of private capital from the United States amounted to $258 million; long-term receipts amounted to $527 million but there was a net outflow of $226 million in short-term funds, while Canadian investments in the United States amounted to $43 million. Direct investment receipts were higher than in 1952, but net new issues were appreciably lower, after allowance is made for the $75 million redemption ahead of maturity of Canadian Government bonds in the second quarter.

As shown by Table 2, direct investments, the most stable of all forms of international investment, accounted for about three quarters of the new capital inflow (apart from reinvested profits) in the eight years 1946–53; and subscriptions to new issues, net of redemption, for a further 11 per cent.7 The more volatile short-term elements—the trade in outstanding securities and other capital movements—together accounted for only 14 per cent of the receipts. The trade in outstanding securities, furthermore, included U.S. purchases of Canadian stocks of at least $80 million and another $144 million of receipts arising from the continuing sale of Canadian holdings of U.S. securities of all types, both of which are probably more of a long-term than a short-term character. U.S. purchases of Canadian bonds, amounting to $386 million for the period as a whole, were thus substantially balanced by outward movements of other forms of short-term capital. Table 2 also shows a small net movement of Canadian long-term funds to the United States, liquidations of direct investment holdings prior to 1950 having been reversed in the next three years.

In addition to transactions which involve international transfers and so influence conditions in the exchange market, the reinvestment of profits by nonresident concerns must be taken into account in order to assess the part played by external capital in Canadian development. The estimates of reinvested profits shown in Table 2 and in the section on direct investment in Chart 3 indicate the importance of this source of external capital. In the eight years through 1953, such reinvestment by U.S. firms amounted to $1,157 million, compared with the actual inflow of $1,794 million in new capital. In the immediate postwar years, 1946–49, they were of even greater importance, being, as the chart shows, the principal source of external capital.

Long-term capital receipts

In past years, long-term capital tended to flow into Canada most actively during periods of high domestic investment, although the movements have not corresponded exactly, since changes in receipts have tended to lag behind changes in domestic investment by one or two years. Thus, as Chart 4 shows, domestic investment reached a peak in 1929, while capital receipts continued to rise until the following year; after the depression, domestic investment began to recover in 1934 while capital flowed out increasingly until 1936; after the war, domestic investment began to rise as early as 1945 but the net capital inflow did not begin until 1948.

Chart 4.Capital Inflow, Imports, and Domestic Investment in Canada, 1926–53

(In millions of Canadian dollars)

1 By U.S.-owned concerns only.

2 For 1927–37 and 1946–53, this series covers direct investments plus new issues (net); for 1938–45, it covers new issues (net) in the United States only.

Sources: Dominion Bureau of Statistics, National Accounts, Income and Expenditure: 1926–50 and 1950–53; The Canadian Balance of International Payments: 1926 to 1948; 1946–62; and 1953 (Ottawa, Canada).

The persistence of a high rate of capital receipts in 1930 may be explained in part by the need to complete projects already begun before the recession, although Canadian Government borrowing to support the exchanges was also a factor. The lag in the postwar upswing is less readily explained. It may suggest that in recent years external capital has been attracted to Canada only by the recognition, after an interval, of the profit opportunities resulting from domestic expansion; in other words, that U.S. capital has been a marginal influence induced by internal developments, rather than an autonomous factor which has played its part in stimulating the internal process.

Such a generalization would be dangerous, however. In the first place, the extent of the lag is somewhat exaggerated in Chart 4. In particular, the sharp increase in external receipts from 1949 onward was due partly to erratic movements in new issues, which are discussed below; the rise in direct investment, as shown by the separate curve on Chart 3, was more nearly parallel with internal investment. In the second place, there is reason to believe that the especially sharp increase in direct investment in 1950 represented a second wave of external capital flow, superimposed on the earlier flow, and responding more directly to the needs of the U.S. economy than to the expansion of the Canadian market.8 Furthermore, the lag and the sharp increase in capital receipts characterize only the flow of new money; reinvested profits, which are affected by the volume of past investments as well as by present opportunities, have been fairly stable since the end of the war. From this it appears that established nonresident concerns have closely followed the investment policies of domestic firms and have shared in the expansion from its beginning.

Chart 4 also shows that, despite the size and obvious importance of the postwar inflow, the dependence of Canadian investment on external sources of capital has recently been less than in the 1920’s. Between 1948 and 1953 receipts of long-term capital (other than reinvested profits) from all sources amounted to more than $2,000 million, of which most—$1,850 million—was received between 1950 and 1953. Over the same six-year period net domestic fixed investment amounted to $15,308 million. Thus the average rate of long-term capital inflow was equivalent to 12 per cent of domestic investment, although the proportion rose sharply from 5 per cent in 1948–50 to between 18 and 19, per cent in 1951–53. From 1928 to 1930, net receipts of long-term capital were equivalent to nearly 25 per cent of net domestic investment, and in 1930 the proportion rose to over 50 per cent.

The contribution of foreign private capital to the Canadian economy has been augmented by its concentration in risk-bearing ventures. Such investments are typically associated with the introduction of new products and techniques. Since 1926, and especially since the end of the war, direct investment capital has comprised an increasing proportion of the total, especially when reinvested profits are taken into account;9 and over 90 per cent of this direct investment has taken the form of equity holdings, mainly stock issued by Canadian firms or subsidiaries.10

Industries financed by direct investment. Since the war, U.S. investment in the extractive industries has risen rapidly (Table 3). These industries have attracted $904 million of U.S. direct investment funds, or 56 per cent of the total gross inflow, against $555 million (35 per cent) entering manufacturing industry, and $139 million (9 per cent) going into other fields of activity. Investment in the oil industry in particular rose from $23 million in 1948 to $98 million in 1950 and to $140 million in 1951. There was a slight reduction in 1952, but if investment in associated transport facilities, such as pipelines, is taken into account the value was probably about the same in both years and continued at approximately the same rate through 1953. Investment in metal mining, in which the development of titanium and iron ore has played a leading part, has followed a somewhat similar course, with especially important increases in 1950 and 1952. Direct U.S. investment in manufacturing industry also rose rapidly in 1950 and 1951, sharing the general domestic expansion. Within this group, the pulp and paper industry has been the principal recipient of U.S. capital, although there were no further U.S. investments in this industry in 1953. The growth of U.S. investment in transportation has been associated largely with the development of the oil and ore fields.

Table 3.U.S. Direct Investment in Canada, 1946–53(In millions of Canadian dollars)
19461947194819491950195119521953Total
Extractive industries2142869128177227259904
Manufacturing industry146454942891148585555
Transportation1810511796
Finance1572388..2..243
Gross investment6366791142433093633611,598
Return of capital258183043394431238
Net inflow385861842002703193301,360
Reinvested profits3129971781871141671271581,157
Other identified transactions–43–35201717341618179
Net increase in book value of direct investment holdings1241202592883314716074962,696

Includes miscellaneous investments.

Included with manufacturing industry.

Includes revaluations, reclassifications, etc.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

Includes miscellaneous investments.

Included with manufacturing industry.

Includes revaluations, reclassifications, etc.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

The recent redirection of new capital into the extractive industries is reflected also in the changing pattern of U.S. holdings. Between 1926 and 1950 this pattern remained fairly stable, with manufacturing industry accounting for 50 per cent of total holdings in both years.11 With the recent emphasis on the extractive industries, however, U.S. holdings in this field rose from a steady 17 or 18 per cent of the total between 1926 and 1948 to 29 per cent in 1952.

The relative importance of recent U.S. investment in the extractive industries is brought out more clearly by Chart 5, which compares U.S. direct investment (including reinvested profits) with total capital formation in the major industrial groups. In the extractive group—which has attracted only 8 per cent of total domestic and foreign investment since the end of the war—U.S. direct investment has accounted for about two thirds of the new investment since 1948. In manufacturing industries, it has provided about one fourth of the new investment. But in commercial and financial concerns and in public utilities, which absorb more capital than any other sector of the economy, direct U.S. investment has been relatively unimportant.

Chart 5.Domestic Investment and U.S. Direct Investment in Canada, by Industry, 1927–53

(In billions of Canadian dollars)

1 New fixed investment by business; includes industries not shown separately.

2 Excludes manufactures of nonmetallic minerals.

3 Includes miscellaneous industries.

4 Includes smelting and manufactures of nonmetallic minerals.

5 Trade, finance, and commercial services.

Sources: Department of Trade and Commerce, Private and Public Investment in Canada: 1926–61 and Outlook, 1952, 1953, and 1954 (Ottawa, Canada). Dominion Bureau of Statistics, The Canadian Balance of International Payments: 1926 to 1948; 1946–52; and 1953 (Ottawa, Canada).

U.S. investment in Canada’s extractive industries is important also because these industries, together with woodpulp and paper, are the staple earners of foreign exchange. In fact, the recent expansion of U.S. investment in these industries appears, to a large extent, to be associated with the increasing U.S. demand for these products. This is most clearly the case with regard to the metals, particularly iron ore, where several of the larger developments are being undertaken directly by the ultimate user firms in the United States.12 According to some reports, certain large-scale developments could not have been undertaken save by a large, integrated concern. In the case of oil, the new foreign investment will not earn foreign exchange since Canada is likely to remain a net importer in the foreseeable future, but the development of domestic production should make possible a considerable saving in this direction. Moreover, even here it appears that a north-south trade may develop, with Canadian oil providing some of the requirements of the northwestern parts of the United States, and U.S. oil continuing to supply eastern Canada.

The recent concentration of the additional receipts of U.S. capital in the export industries contrasts with the earlier pattern of direct investment, which was more widely dispersed over manufacturing industry and commercial and financial services. While the earlier investment also contributed to export earnings, especially in the pulp and paper industries, it probably produced relatively more for the Canadian domestic market. It also seems significant in this context that Canadian capital has not shown a similar tendency to concentrate in the export industries. From these standpoints, therefore, it may be said that the stimulus to U.S. investment in Canada has shifted, from Canadian needs and domestic expansion before 1949 to U.S. needs for Canadian products since then.

New issues. The flow of U.S. capital into new issues of Canadian securities (net of redemptions) has tended to move, like direct investment, in broad harmony with the movement of domestic investment. There were net redemptions throughout the war years; but with the rise in domestic capital formation since 1946 there has been a clear trend toward larger net borrowing. This similarity of trend is shown in the upper panel of Chart 6.

Chart 6.Net New Issues of Canadian Securities in the United States and Related Factors, 1940–53

1 Canadian Government theoretical 15-year bonds.

2 U.S. Government long-term bonds.

Sources: Dominion Bureau of Statistics, National Accounts, Income and Expenditure, 1926–50 and 1950–58; and The Canadian Balance of International Payments: 1926 to 1948; 1946–52; and 1958 (Ottawa, Canada). Bank of Canada, Statistical Summary (Ottawa, Canada). Treasury Department, Treasury Bulletin (Washington, D.C.).

There have, however, been considerable irregularities from year to year which appear to be explained largely by changes in the relative levels of interest rates in the two countries. In the center panel of the chart net new issues are shown with the effects of the trend in domestic investment eliminated; and shorter-term fluctuations in borrowing are linked with changes in the spread between Canadian and U.S. long-term interest rates. As the bottom panel shows, Canadian rates have, as a rule, been at least one half of one per cent higher than those in the United States, but variations in this difference have corresponded closely with the shorter-term fluctuations in new Canadian issues in the U.S. market.

Another factor affecting the level of net new issues may have been fluctuations in the exchange rate. Particularly for maturing issues, the possibility of some appreciation in the rate would tend to provide an incentive to Canadian debtors to refund their obligations in the United States rather than to retire them; conversely, new issues may be discouraged when the rate is at an historically high level, as in 1952. At times the rate of redemption has been affected by exchange control regulations; and at times government borrowing to support official reserves has also been a special factor tending to raise the level of new issues.

Although new issues in the United States have been relatively small for the postwar period as a whole, there have been important shifts in the amount of funds among different types of borrowers, which are illustrated in Table 4. Provincial and municipal governments have raised about $480 million (net) in the United States, while the federal Government has on balance reduced its issues in the United States by $200 million, and corporations have reduced their U.S. obligations by $20 million. Equity issues have been small, but of increasing importance in 1951–53.

Table 4.New Issues and Retirements of Canadian Securities in the United States, 1946–531(In millions of Canadian dollars)
19461947194819491950195119521953Total
Gross and net
Gross new issues218951501052104043153291,826
Retirements–460–313–96–136–263–159–75–132–1,634
Net new issues–242–21854–31–53245240197192
Net, by type of security
U.S. dollar bonds
Government of Canada–151–3214827–72–48–1–75–204
Provincial and municipal–43–21–38–143428593181477
Corporate–44–121–12–1211–610754–23
–238–174981–272311991602250
Canadian dollar bonds15–27–43–31–28–2120….–115
Stocks–19–17–1–1235234062
Net new issues–242–21854–31–5324524232004197

No sign indicates increase; minus sign indicates decrease.

Includes Canadian dollar bonds.

Unrevised.

Includes net new issues of $3 million in other countries.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

No sign indicates increase; minus sign indicates decrease.

Includes Canadian dollar bonds.

Unrevised.

Includes net new issues of $3 million in other countries.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

In 1946–47, as the table indicates, redemptions were unusually heavy: several Canadian Government issues were redeemed, and the upward revaluation of the Canadian dollar in July 1946, together with a relative rise in U.S. interest rates, led to heavy redemptions by other debtors. Corporate, provincial, and municipal redemptions continued, although reduced by control measures, through 1949. During 1948 and 1949 the federal Government was virtually the only Canadian borrower in the United States.13 In 1951 and 1952 the relative increase in interest rates and other forms of credit restrictions in Canada seem to have been factors in the rise in external borrowing, first by governments and later by corporations. The volume of retirements also declined correspondingly. Net new issues fell during 1953 mainly as a result of the federal Government having redeemed $75 million of its bonds ahead of maturity; new borrowing was also affected by a relative rise in U.S. interest rates during the second and third quarters.

While net new security issues have not added appreciably to U.S. portfolio holdings in Canada since the war, the value of these holdings has nevertheless risen by $799 million, or 31 per cent, mostly since the beginning of 1950. The increase has been due to rising book values and purchases of outstanding securities, mainly of corporate issues other than public utilities. Holdings of Canadian Government bonds rose abruptly in 1950, but fell again in the two following years and at the end of 1952 were little higher than at the end of the war; these transactions, however, are more properly regarded as part of the short-term capital flow.

Nonresident ownership of Canadian industry. A corollary of the movements of direct investment and purchases of equity securities has been a rise in the proportion of U.S. ownership in extractive industry from 31 per cent in 1939 to 52 per cent in 1951 (Table 5). Enlarged U.S. security holdings in oil refining companies have similarly tended to sustain the U.S. percentage in manufacturing. Aside from refining and automobiles (which are almost entirely in the hands of U.S. subsidiaries), the percentage of U.S. ownership in manufacturing industry is probably considerably less than 36 per cent. In the railway and utility industries, the diminishing importance of non-U.S. capital—particularly British—was largely a matter of war finance. The proportion of Canadian industry in nonresident ownership as a whole had fallen from 38 per cent before the war to 32 per cent in 1951.

Table 5.Percentage of Selected Canadian Industries Owned by U.S. and Other Nonresidents, 1939 and 1951
U.S.Other
1939195119391951
Manufacturing industry343687
Extractive industry315297
Steam railways18183921
Other utilities201773
Total of above industries and merchandising2224168
Source: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1953 (Ottawa, Canada).
Source: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1953 (Ottawa, Canada).

Short-term transactions

The two components of the short-term capital flow, transactions in outstanding securities and “other” capital movements, have moved roughly together (see Chart 3), but more or less independently of long-term capital and domestic investment. Furthermore, short-term transactions have been especially sensitive to exchange rate developments, both during the period of fluctuating exchange rates since 1950 and at earlier times when there were alterations in the fixed parity.

Transactions in outstanding Canadian securities. During the late 1920’s, transactions in outstanding securities entailed an outflow of capital for the purchase of U.S. securities which in some years was almost heavy enough to offset the inflow of long-term funds. This process came to an end in 1929, and there were few transactions during the next decade. In the war years, and especially from 1941 through 1946, there was a heavy and consistent inflow of funds for the purchase of Canadian securities. This subsided during the years 1947–49 and was followed by a further heavy inflow in 1950 and an outflow in 1952.

Table 6.Net Transactions in Outstanding Securities Between the United States and Canada, 1943–531(In millions of Canadian dollars)
Annual

Average

1943–46
1947194819491950195119521953
Canadian securities
Federal and local government103–3–810200–87–184–84
Corporate3201–21759816
Other21080121714548–1–2
Non-Canadian securities351–2–9196818920
Total294–5–44443038–95–60

No sign indicates inflow to Canada; minus sign indicates outflow from Canada.

Consists principally of securities, mainly bonds, traded through channels other than the reporting dealers.

Principally U.S. stocks.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1926 to 1948, and Sales and Purchases of Securities Between Canada and Other Countries (Ottawa, Canada).

No sign indicates inflow to Canada; minus sign indicates outflow from Canada.

Consists principally of securities, mainly bonds, traded through channels other than the reporting dealers.

Principally U.S. stocks.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1926 to 1948, and Sales and Purchases of Securities Between Canada and Other Countries (Ottawa, Canada).

The characteristically short-term part of this movement was focused on government bonds, both federal and local (Table 6). Most of the purchases of Canadian corporate securities, both stocks and bonds, took place after 1950, at a time when government bonds were being sold, which suggests that corporate security transactions might more properly be regarded as part of the long-term capital flow.

Over the past ten years, transactions in Canadian bonds appear to have been influenced mainly by exchange rate policy, movements in relative interest rates, and exchange control regulations (Chart 7). In each of the years 1943–46, as well as in 1942, there were heavy purchases of Canadian bonds by U.S. investors. One factor in these purchases was the spread of around one half of one per cent between Canadian and U.S. Government bond yields. A second factor was the strength of the Canadian payments position, which led to expectations of an eventual appreciation in the exchange rate and thus provided an incentive for speculatively minded investors. This was probably a major factor in the rise of U.S. purchases to a peak during the first quarter of 1946, prior to the upward revision of the official parity at the end of June. The decline in bond purchases after the first quarter may also have been accentuated by withdrawal in January 1946 of the privilege of registering bond investments for subsequent repatriation, as well as by a narrowing of the spread between Canadian and U.S. interest rates.14 Nevertheless, there were few periods of net sales during the ensuing three years; nor were there many signs of a movement out of Canadian bonds during the period of exchange weakness in 1947. On the other hand, the strengthening of the free market exchange rate and the relative rise in Canadian bond yields in the first half of 1948 appear to have had little or no influence on bond transactions.

Chart 7.Canada’s Trade with the United States in Outstanding Canadian Bonds, and Related Factors, Quarterly, 1943–53

1 Canadian bonds, as reported by Canadian dealers.

2 Canadian Government theoretical 15-year bonds.

3 U.S. Government long-term bonds.

Sources: Dominion Bureau of Statistics, Sales and Purchases of Securities Between Canada and Other Countries (Ottawa, Canada). Bank of Canada, Statistical Summary (Ottawa, Canada). Treasury Department, Treasury Bulletin (Washington, D.C.). Board of Governors of the Federal Reserve System, Federal Reserve Bulletin (Washington, D.C.).

In 1949 two developments tended to restore the attractiveness of Canadian bonds for U.S. investors. Bond registrations were permitted once more in May, and the Canadian dollar reverted to US$0,909 in September. Purchases began to rise during late 1949 and the first half of 1950, and in the third quarter of 1950 rose precipitously to $189 million, equivalent to an annual rate of about $750 million. A major factor in this development appeared to be a popular expectation of an appreciation of the exchange rate.

Instead of a new parity at a higher level, however, the Government announced that it was withdrawing support from the official parity, and after September 30, 1950 would allow the rate to be determined primarily by market forces. The Canadian dollar rose immediately, averaging US$0.953 during the fourth quarter of 1950, and net purchases of Canadian bonds fell off sharply. The downward trend continued during 1951, developing into a heavy outflow beginning with the second quarter.15 In the absence of official intervention, however, the outflow was supported only by other U.S. funds becoming available through market channels, and it therefore had an equilibrating influence, tending to moderate the rise in the exchange rate. By the fourth quarter of 1952 the exchange rate had reached a peak and begun to decline, and the rate of bond sales also moderated. During 1953 the exchange rate was relatively stable at around US$1.02, and net bond sales were light except in the second quarter when a sharp rise in U.S. bond yields brought renewed selling of Canadian bonds by U.S. investors.

Transactions in U.S. securities. In recent years nearly all transactions with the United States in non-Canadian securities have involved U.S. stocks; dealings in U.S. bonds have been unimportant. Until the end of 1951, Canadian residents were unable to enlarge their net holdings of U.S. securities except through the previous sale of Canadian stocks payable in U.S. dollars. This limitation, together with the appearance of attractive investment opportunities in Canada, tended to result in the net repatriation of Canadian funds indicated in Table 6. Especially large sales in 1950 may be explainable by the rise in Canadian stock prices and by the prospect of exchange rate appreciation.

“Other” short-term transactions. “Other capital,” as shown in Chart 3, is a residual category which consists principally of private short-term transactions. It includes also errors and omissions from other categories and certain long-term transactions not recorded separately; in particular, during the war years 1939–44 it included all direct investments in Canada. The composition of these transactions over the past five years is shown in Table 7. The bulk of the transactions recorded in this category consists of changes in bank balances and corporate-affiliate accounts. The remainder consists mainly of loans and advances between unaffiliated parties.

Table 7.“Other Capital” Transactions (Net) Between the United States and Canada, 1949–531(In millions of Canadian dollars)
19491950195119521953
Short-term transactions
U.S. holdings of Canadian dollars
–889–53–37–1
Canadian holdings of U.S. dollars

–20
8–30


–458


–165
Commercial credit20654
Other–183627
Long-term transactions….–18————
Total–463386–495–166

No sign indicates inflow to Canada; minus sign indicates outflow from Canada.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1958 (Ottawa, Canada).

No sign indicates inflow to Canada; minus sign indicates outflow from Canada.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1958 (Ottawa, Canada).

During the war and postwar years, the total of “other capital” has moved in broad harmony with the trade in outstanding bonds. Thus there was an inflow during the war years as U.S. residents increased their holdings of Canadian dollars and allowed their Canadian accounts receivable to rise; this inflow came to an end with the appreciation of the Canadian dollar in June 1946. The weakness of the free exchange market in 1947 led to some speculation against the Canadian dollar, but on balance the outflow was small, since speculation by Canadian residents was restricted throughout by the exchange control and the domestic demand for capital was rising rapidly.16 Again, prior to the devaluation of 1949 there was some outward pressure, as shown in Table 7. During 1950 there were capital inflows in all categories, rising to a peak during the third quarter.17

After the suspension of the fixed parity in October 1950, the movement of bank balances turned outward and remained so throughout 1951; among other types of short-term capital, a further heavy inflow during the first half of the year gave way to an equally pronounced outflow during the second half as the exchange rate rose. In the aggregate, however, these various forms of “other” capital showed virtually no net movement over the year as a whole. The outflow in all categories continued during the first nine months of 1952, but fell away rather abruptly in the fourth quarter. During 1953 the short-term outflow continued at a much reduced rate.

The influence of exchange expectations on short-term capital movements was especially apparent during 1950 and 1952, as the expectation of an appreciation of the Canadian dollar first created incentives for an inflow of both bank balances and commercial credit, and the later realization of that appreciation tended to stimulate a profit-taking outflow. Commercial credit was affected in 1951 by the rise in foreign trade, and the increase in intracompany credits probably also reflected interim credit for long-term development schemes. An additional factor was the comparative shift in credit conditions in the two countries, particularly in the first half of 1951, when the inflow was largely a reflection of the more vigorous restriction of credit in Canada; the subsequent rise in short-term interest rates in the United States during 1952, combined with a premium on forward exchange, provided an incentive for Canadians to increase their U.S. balances. The final abolition of Canadian exchange controls in December 1951 facilitated this movement.

Capital from Other Countries

Long-term capital

The United Kingdom has always been the largest overseas source of funds for Canadian development. During the war and immediate postwar periods the value of British assets in Canada fell by more than a third, from $2,476 million in 1939 to $1,593 million at the end of 1948. Since 1948 private holdings have risen once more, and at the end of 1952 they approached $2,000 million.18

The wartime liquidations were due principally to the redemption before maturity of over $700 million of direct and guaranteed Canadian Government bonds held in the United Kingdom. There was also private liquidation of about $500 million to the end of 1948, much of which was offset by an increase in the book value of the remaining assets. To some extent, private liquidations were matched by a reduction of official indebtedness. Under the terms of the 1942 loan agreement with the United Kingdom, this indebtedness was to be reduced out of the Canadian dollar proceeds of any redemptions or sales of privately held securities. By March 1948 the outstanding balance had been reduced by these means to $297 million. The rise of over $200 million in book value after 1948 was in part merely statistical, owing to the inclusion of Newfoundland in the Canadian statistics in 1949. The increase since then, however, has been unequivocal, and can be attributed mainly to reinvested profits. New transactions included portfolio liquidations of $85 million, offset by an inflow of funds for direct investment purposes of $119 million, leaving a net inflow of $34 million in private long-term funds for the five years 1949–53 (Table 8).

Table 8.Canadian Capital Transactions with the Sterling Area, 1949–531(In millions of Canadian dollars)
19491950195119521953Total
Transactions in portfolio securities–23–51–32–829–85
Direct investments (gross)21319301542119
Private long-term capital–10–32–277134
Other transactions3–30–4376–81–18–96
Intergovernment loans (net)–115148376435
Sterling area holdings of Canadian dollars462116–128–22–1612
Total capital transactions5–9342–6–59101–15

No sign indicates net inflow to Canada; minus sign indicates net outflow from Canada.

Investment by Canadians in overseas countries is included with “other transactions.”

Includes direct investments of $55 million in the sterling area by Canadians, and, in the opposite direction, in 1951–52, advances of $47 million by the U.K. Government to the Aluminium Company of Canada, Ltd.

Mainly official holdings.

Excludes changes in Canadian-held sterling balances.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

No sign indicates net inflow to Canada; minus sign indicates net outflow from Canada.

Investment by Canadians in overseas countries is included with “other transactions.”

Includes direct investments of $55 million in the sterling area by Canadians, and, in the opposite direction, in 1951–52, advances of $47 million by the U.K. Government to the Aluminium Company of Canada, Ltd.

Mainly official holdings.

Excludes changes in Canadian-held sterling balances.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1953 (Ottawa, Canada).

Annual additions to British direct investments were apparently very small until 1948. After the war, the 1942 agreement was modified to permit funds accruing from the sale of portfolio holdings to be used for approved direct investments in Canada as well as for official repayment, and annual receipts under this head ranged between $13 million and $30 million from 1949 through 1952. Early in 1953 it was announced that the British exchange authorities were prepared to make available, on a considerably more generous scale than previously, exchange for direct investments in Canada. British investments reached $42 million during the year. Furthermore, in August 1953 the U.K. Government undertook to repay the outstanding balance of the 1942 loan—$189 million—in regular installments. Consequently, the proceeds of private portfolio liquidations are no longer under earmark and the steady reduction of holdings under this head appears to have been checked.

The exchange of private assets for government liabilities helps to explain a marked shift in the pattern of private British holdings. The net effect of the wartime liquidations fell almost entirely on portfolio holdings, principally bonds, which were reduced from $1,990 million in 1939 to $1,317 million in 1945. In the same period, the value of British direct investments remained stable at around $350 million; by the end of 1952, they had risen to over $500 million (including reinvested earnings), while portfolio holdings fell to little more than $1,200 million.

Most of the postwar direct investment has been in manufacturing industry, especially in the consumer goods trades, although there has also been British investment in the engineering and aircraft industries. British interests in the merchandising and service trades also have expanded in recent years. In contrast, the value of British holdings in financial concerns, always an important field, fell somewhat through 1952. Recently there has been some British investment in the extractive industries.

Assets held in Canada by residents of countries other than the United States and the United Kingdom varied between $330 million and $350 million from 1945 through 1949, but by the end of 1952 they had risen to almost $500 million. Most of the increase was in the form of direct investments, but there were also substantial purchases of Canadian securities in 1951 and 1952.

Short-term capital

Short-term transactions with other countries, while much smaller in amount, have tended to move parallel with those involving the United States. Private short-term capital transactions with the United Kingdom are limited by the British exchange control, and the balance of security transactions is consistently outward. Official sterling area holdings of Canadian dollars, however, rose in 1950 by more than $100 million; this was followed by a corresponding reduction during the following two years. With other countries also, there was a small inflow of short-term capital during 1950, followed by an outflow during 1951–53.

Canada’s Attraction for External Capital

Canada’s success in attracting private development capital stands in sharp contrast to the experience of many other developing countries. The factors underlying this success cannot be summed up in a single sentence; and the present statement of them can be only tentative and general. The salient point is that not only does the growth of the Canadian economy offer profitable openings for foreign capital; there is also a marked absence of features which are normally regarded as obstacles to the international movement of funds. Beyond this, Canada has perhaps a special advantage in its geographic position and cultural affinity with the major capital-exporting countries.

Since the war Canada has offered increased investment opportunities for the foreign investor, and especially for U.S. business concerns. Until 1950 these opportunities arose largely from the expansion of Canadian markets, as is illustrated by the continuing growth of U.S. investments in manufacturing industry and in distribution and finance. Since 1950 the increasing demand for raw materials in the United States, coupled with rising production costs for some U.S. minerals, has led to accelerated investment in Canada’s extractive industries.

As important for business investment as the expanding market for Canadian products have been the economic factors permitting profitable operation. These include adequacy of labor supply (in terms of both quantity and skill), availability of materials, managerial freedom, and the level of business taxes.19 The net effect of these factors can be estimated by reference to business earnings after taxes. As Table 9 indicates, representative samples of Canadian companies have typically had slightly higher rates of net income than U.S. companies. Other data suggest, however, that the Canadian companies and branches which were U.S.-owned may have earned a little less—about 12.5 per cent in 1950.20

Table 9.Net Income After Taxes of U.S. and Canadian Corporations, 1946–52(Percentage return on equity)
1946194719481949195019511952
U.S. corporations19.512.314.011.013.411.410.4
Canadian corporations210.012.314.412.714.113.311.6

National City Bank of New York, sample of over 3,000 U.S. companies.

Bank of Canada, sample of 697 Canadian companies.

National City Bank of New York, sample of over 3,000 U.S. companies.

Bank of Canada, sample of 697 Canadian companies.

The favorable earnings of Canadian corporations have also attracted increased portfolio investment by individuals and institutions. One attraction of fixed-interest-bearing securities has been the relatively higher yields obtainable on long-term Canadian compared with U.S. bonds—typically one half to one per cent more.21 Under the Double Taxation Convention of 1942 with the United States, dividends and interest accruing to nonresidents are subjected in Canada to only a 15 per cent rate, and this is allowable as a credit toward the U.S. federal tax liabilities of the recipient. There are similar agreements with the United Kingdom and some other countries. Probably Canadian borrowing in the United States is also facilitated by the absence of any record of widespread defaults by public or private borrowers and by the fact that Canada has probably drawn on the U.S. capital market for a longer time than any other country. This may be reflected in the preferential eligibility enjoyed by Canadian securities in the United States under certain state banking and security laws.

In addition to profitable investment opportunities, Canada appears to offer accessibility of earnings and a minimum of the risks to security of property that sometimes trouble foreign investment elsewhere. As regards security of property, there appears to be virtually no danger of loss in Canada through appropriation or civil disturbance. As regards transferability of capital, the wartime exchange controls tried to avoid discouraging foreign capital by providing for the registration of new funds invested after 1939, with a right of subsequent repatriation. Transferability of earnings was only nominally restricted until 1951, and the dismantling of the exchange control apparatus in December 1951 removed the last official obstacle to the free movement of funds. The moderate fluctuation of the exchange rate since September 1950 has not had a perceptibly deterrent effect on the flow of long-term funds.

Government policies have contributed positively also to the general economic conditions affecting both domestic and foreign companies. This is evidenced by the avoidance of serious inflation despite a very high rate of domestic investment since the war and the considerable success in avoiding recourse to direct controls over the domestic economy.

The extent to which Canadian tariff policy has stimulated foreign investment is perhaps debatable. In the past, protective tariffs probably have operated with this effect, particularly after they were raised in 1930.22 In some cases, such as automobiles, U.S. investment was further attracted to Canada by the possibility of selling goods of Canadian manufacture inside the British Commonwealth at preferential tariff rates. It is doubtful, however, whether the postwar capital influx has been much affected by the tariff. Investment in resource development is almost entirely unaffected by tariff policy, and the Canadian tariff on manufactures has been reduced in many directions since the war. Even though the existing tariffs still presumably have some continuing influence on U.S. investors, there has been no fresh impetus from this source, and the effect of the general lowering of rates must have been to reduce the importance of the tariff as a factor in attracting foreign capital.23

Beyond the economic and governmental factors, Canada has tended to attract foreign capital because of cultural and social similarities with the major capital-exporting countries, the United States and the United Kingdom. This has made it easy for foreign business concerns to understand the needs and market psychology of the host country, and also to avoid actions which in other countries may have aroused popular antagonism to foreign enterprise.

Interaction of Capital Movements with the Current Account Balance

Over the past 25 years, private capital movements have tended at times to offset the current account balance and at other times to reinforce it. As is shown in Chart 8, during the periods of fluctuating rates from 1929 to 1939 and from 1950 onward there was a strong tendency for the balances on current and capital account to move in opposite directions. During these years the rate appears to have been subject to little sustained official intervention, and the inverse correspondence was apparently due largely to compensating movements of short-term capital. In contrast, between 1939 and 1950, when Canada followed a policy of fixed exchange rates, there was some tendency for the current and capital account balances to move in the same direction, with consequent wide variations in reserves. During most of the 1939–50 period, the position was complicated by official financing of exports on a large scale and by the maintenance of exchange controls in Canada; nevertheless, as was described in an earlier section, the capital account in this period also was strongly influenced by the movement of short-term funds, which again were largely evoked by expectations of changes in the rate of exchange. The disequilibrating effect of these transactions was particularly noticeable between 1941 and 1946 and again in 1950.

Chart 8.Canadian Balance of Payments, 1926–53

(In millions of Canadian dollars)

1 Includes Mutual Aid beginning with 1950.

2 Includes sterling balances after 1946. Data for 1936–39 are not available.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–62 and 1958 (Ottawa, Canada).

Long-term capital and the trade account

The relationship of the current account to long-term capital movements has, however, been more consistent than its relationship to the aggregate capital account: irrespective of the exchange rate system, movements of long-term capital and of the current account have shown a broad tendency to offset one another. Thus, between 1927 and 1931 current account deficits were financed by an inflow of long-term funds, while from 1933 through 1948 a series of current account surpluses was accompanied by a consistent outflow of long-term capital. The relationship has clearly asserted itself once more since 1950, a tendency toward current account deficits being accompanied by record receipts of long-term funds. This connection was present also during each of the earlier phases of Canadian expansion, extending back at least to 1900.

The correspondence between periods of current account deficits and long-term capital receipts, which is by no means automatic or invariable, is best explained by reference to the separate relationship of each to domestic capital formation. This is illustrated by Chart 4, which shows a strong correlation from 1926 to 1953 between domestic investment and imports, and a moderate correlation between domestic investment and long-term capital movements. That is, the pressure on resources which typically accompanies an investment boom tended to raise imports, while the development opportunities which attracted domestic capital tended also to attract foreign capital. There is thus a marked tendency, from the side of imports at least, for current account deficits to develop in years of high investment activity, and for these deficits to be financed in part by a concurrent inflow of capital.24 The relationship illustrates, in fact, how a capital inflow serves to supplement the internal resources of the economy and thus to permit a higher rate of over-all investment than would otherwise have been possible without intensifying inflation or payments difficulties.25

Long-term capital and the service account

In addition to financing a series of current account deficits, the long-term capital inflow has also influenced the structure and pattern of the current account itself. The postwar increase of 46 per cent (through 1952) in the value of external investments in Canada has tended to be accompanied by a similar increase in remittances of interest and dividends to nonresidents.26

More significantly, however, investment income payments have represented a diminishing payments burden, since gross receipts on current account have risen even more rapidly—by 68 per cent—over the same period. This has meant that the effective burden of these payments declined from 9.3 per cent of current receipts in 1946 to 7.0 per cent in 1953—a trend that appears to be more than a short-run fluctuation, since in 1927–29 investment income payments were equivalent to almost 17 per cent of current earnings. Basically it seems to signify a strengthening of the balance of payments position as a result of rising export capacity and the decreasing dependence of the economy on external sources of capital.27

Between 1938 and 1952 the proportions of fixed and variable investment service also tended to shift so as to reduce the relative burden of fixed payments during periods of business depression. As Table 10 shows, the increase in investment income payments since 1938 has been entirely on equity investment; interest payments, mainly on behalf of private debt, have fallen.28

Table 10.Canadian Investment Income Payments to Nonresidents, 1938 and 1946–53(In millions of Canadian dollars)
19381194611947194819491950195119521953
Dividends179187224221286366336298289
Interest on public debt7069595558646866
121
Interest on private debt25856544946454649
Total interest128125113104104109114115121
Total payments307312337325390475450413410
Interest as per cent of total payments424033322723252830

Partly estimated.

Includes interest payments on direct investments.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments: 1926 to 1948; 1946–52; and 1953 (Ottawa, Canada).

Partly estimated.

Includes interest payments on direct investments.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments: 1926 to 1948; 1946–52; and 1953 (Ottawa, Canada).

It also seems likely that the change since 1950 in the industrial pattern of external investment has added to the strength and stability of the current account position, especially vis-à-vis the United States. Before 1950, as pointed out earlier, U.S. capital tended to enter industries selling to the domestic Canadian market, and thus gave relatively little direct support to the payments position. The more recent concentration of U.S. investment in the extractive industries appears, more than ever before, to have increased Canadian export capacity and to have reduced the degree of dependence on imports.29 Moreover, the close integration of Canadian industries with U.S. manufacturing firms, which was mentioned especially in the case of iron ore, may mean that Canada will become a more consistent (i.e., less of a marginal) supplier of these materials to the U.S. market, thus lessening the amplitude of fluctuations in exports to the United States, which in the past has been a cause of instability in the current account.

Short-Term Capital and the Fluctuating Rate

While long-term capital has tended to move inversely with the current account balance, the previous analysis has indicated that the relation of short-term capital to the current account has varied according to the exchange rate system. This characteristic of short-term funds has been, in fact, a major consideration in Canadian exchange rate policy since 1950.30

The story of this period began in the first three quarters of 1950, while there was still a fixed exchange rate. Long-term capital was entering in increasing volume and, while there was an over-all deficit on current account, the trade balance with the United States was improving and reserves were rising. Some of the investment developments received widespread publicity in the United States, leading to expectations of an ultimate strong improvement in the payments position. An inflow of short-term funds—largely speculative—quickly developed during the second and third quarters, which tended to increase the money supply and threatened to add seriously to inflationary pressures.31 These factors were the proximate cause of the decision to suspend support of the fixed exchange rate at the beginning of October.

Since then, as Chart 9 illustrates, the exchange rate has tended to move in response to changes in the balance on current account and long-term capital. The chart suggests, however, that the response has been general rather than precise, sometimes lagging by one or two quarters.

Chart 9.Canadian Exchange Rate and Balance of Payments, Quarterly, 1950–53

MILLION CAN DOLLARS

1 Includes intergovernment transactions.

2 Includes changes in sterling balances.

Sources: Dominion Bureau of Statistics, The Canadian Balance of International Payments, 1946–52 and 1958. Board of Governors of the Federal Reserve System, Federal Reserve Bulletin (Washington, D.C.).

These movements of the exchange rate have tended to evoke short-term capital movements—an outflow as the exchange rate has risen and a tendency toward an inflow when the exchange rate has softened. Thus, when in the fourth quarter of 1950 the exchange rate rose to Can$1.00 = US$0.95, the short-term inflow came to an end; as the rate weakened in the first half of 1951 and subsequently strengthened, short-term capital moved inversely, first in and then out; and the more recent cycle of the exchange rate, weakening to mid-1953 and then recovering, was accompanied by an inverse cyclical movement of short-term funds.

In addition, as observed in the earlier analysis of transactions in outstanding securities, the short-term capital movement has responded to credit conditions in the two countries. Credit stringency was a factor in the movement of funds to Canada during the first half of 1951, and the narrowing of the spread between Canadian and U.S. interest rates in 1952–53 (as U.S. rates hardened) appears to explain the tendency for short-term capital to flow out at a more rapid rate than can be accounted for by the influence of the exchange rate. To some extent the motivation for the 1951–52 outflow was probably reinforced also by the incentive to take a profit on the speculative position established in 1950.

Throughout the period of fluctuating rates it has been the policy of the authorities to abstain from intervention in the market except to ensure orderly conditions by smoothing out excessive short-run fluctuations in the rate. Such intervention may account for the relatively wide quarter-to-quarter changes in reserves during 1951. Over the three-year period to December 1953, however, official reserves of gold and U.S. dollars rose only moderately, from US$1,741 million to US$1,818 million.

The responsiveness of short-term funds to the exchange rate has probably reduced the magnitude and frequency of exchange rate fluctuations that would otherwise have occurred in response to variations in the balance on current and long-term capital account, and probably also the extent of movements in the official reserves. The fact cannot be overlooked, of course, that the effectiveness of moderate rate fluctuations in attracting equilibrating capital movements has depended on the substantial price and credit stability of the Canadian economy vis-à-vis the major trading partners, and on widespread confidence that government policies will continue to favor such stability. For it would seem to be this stability, and the confidence in it, which has provided a rallying point for market opinions as to the appropriate long-run level of the rate, and thereby encouraged the taking of a speculative position whenever the rate deviated from this level for shorter periods.32

In this connection a shift may be observed during the last three years in market sentiment as to the appropriate exchange rate warranted by the present and prospective balance of payments. In the second quarter of 1953, for example, the balance on current and long-term capital account was approximately the same as in the last quarter of 1950, and short-term capital movements also were approximately in balance in both quarters. Yet the exchange rate in the later quarter was about Can$1.00 = US$1.01, against US$0.95 in the earlier quarter. From the data it may plausibly be inferred that during most of 1951 market sentiment as to an appropriate rate centered around US$0.95, but that it was revised upward during 1952 after the sharp rise in the balance on current and long-term capital account which took place at the end of 1951. During 1953 this confidence was apparently maintained, as speculative transactions were relatively light while the rate moved narrowly between about US$1.005 and US$1.028.

Domestic Effects

The foregoing analysis has brought out the part played by the postwar capital inflow in the expansion of the Canadian economy. Domestic savings have been augmented by net receipts of new capital to the extent of about 12 per cent, a ratio that is apparently lower than in the 1920’s. But the relative importance of foreign capital has been much greater in the development of the extractive and other export industries, especially those requiring large concentrations of capital. This reflects to an important extent the sharp rise in foreign demand for Canadian export products in 1950, which has contributed materially to the growth of the national income. There remains to consider the short-run effects of the capital inflow on the stability of the domestic economy.

The heavy receipts of all types of capital during the last few years have represented a potentially inflationary factor through their influence on the money supply and on the credit base.33 Furthermore, during the period of fixed exchange rates, these effects were aggravated by the coincidence of periods of capital inflow with current account surpluses. This was the case during the war, and again in 1948 to 1950; conversely, in 1946–47 a private capital outflow coincided with deficits on current account, after allowance for official capital movements. The combined effects of these transactions on the official reserves, and hence on the domestic money supply, is shown for the postwar years in Table 11.

Table 11.Changes in Canada’s Money Supply, and Related Factors, 1946–53(In millions of Canadian dollars)
194619471948194919501951195219531
Changes in money supply29472356564305392556543
Factors increasing money supply155–6641,2164281,0876350503
Gold and foreign exchange holdings3–183–761516210665–49–19–42
Federal government securities4–132–690443140–109–776619
Bank loans and other security holdings47078725778531132303526
Factors decreasing money supply–792–899560–2548–19–215460
Federal government cash surplus after retirement of domestic debt (net)–661–864568–1461495–45….
Advances to Exchange Fund–25–77052012551521696….
Deposits with banks5–686–9448–18999–120–141507
Capital and other liabilities of monetary system (net)–131–35–812–66–114–170….

Partly estimated.

Currency and total deposits held by the general public.

In Exchange Fund and Bank of Canada.

Holdings of banking system and Exchange Fund.

Excludes deposits of Exchange Fund.

Sources: Foreign Exchange Control Board, Annual Reports (Ottawa, Canada). Bank of Canada, Annual Reports and Statistical Summary (Ottawa, Canada).

Partly estimated.

Currency and total deposits held by the general public.

In Exchange Fund and Bank of Canada.

Holdings of banking system and Exchange Fund.

Excludes deposits of Exchange Fund.

Sources: Foreign Exchange Control Board, Annual Reports (Ottawa, Canada). Bank of Canada, Annual Reports and Statistical Summary (Ottawa, Canada).

During the period of fixed rates from 1939 through 1950, Canada pursued a policy of partially sterilizing additions to the official reserves. Gold and foreign exchange receipts were acquired by the Exchange Fund, which is financed by advances from the federal Government; thus, in effect, increments to the reserves were paid for by a reduction in government balances with the chartered banks. This arrangement, by avoiding the use of central bank credit, operated to insulate the cash reserves of the chartered banks from the effects of external transactions, although an accession to foreign exchange reserves did tend to add correspondingly to private deposits. Between 1947 and 1952, however, the inflationary impact of these additions to the money supply was reduced by a series of federal cash surpluses, which provided the funds advanced to the Exchange Fund and also permitted an appreciable reduction of domestic indebtedness. Thus the impact of the swings in the balance of external transactions on the domestic economy was moderated by the fiscal and monetary policies of the Government.

During the third quarter of 1950, however, the inflow of capital exceeded the available cash resources of the federal Government; of an increase in reserves of $589 million in that quarter, only $96 million was financed as described above; $293 million was acquired by the Bank of Canada and the Government borrowed $200 million temporarily from the banking system. For a variety of reasons the Government felt that this domestic problem could be met only by checking the capital inflow through letting the exchange rate respond to market forces. Since the inception of a fluctuating exchange rate in October 1950, movements of the exchange rate have tended to provoke equilibrating short-term capital movements, with the result that external transactions have been approximately in balance. This has almost entirely neutralized the monetary impact of the payments position as a whole on the domestic economy, and has reduced the need for stabilizing action by the fiscal and monetary authorities.

Mr. Radford, economist in the North American Division, is a graduate of the University of Cambridge.

This paper is concerned primarily with private capital movements; inter-government transactions, while almost as large as receipts on private account since the war, are not specifically discussed. Figures are in Canadian dollars.

The coincidence with domestic capital formation is illustrated in Chart 4; that with current account deficits is shown in Chart 8.

If intergovernment indebtedness is taken into account, the creditor position of the United Kingdom with Canada was almost extinguished as a result of World War II.

These figures take no account of short-term private credits or changes in the external assets of Canadian insurance companies and banks. Movements in official reserves and intergovernment credits are also excluded.

Between 1950 and 1952 national income per capita averaged $1,182, against $1,751 in the United States, and private savings per capita averaged $136, against $158 in the United States. All figures are in Canadian dollars.

The validity of this rough grouping, and the forces influencing the behavior of the various types of transaction, are discussed more fully in later sections.

The predominance of direct investments is peculiar to the postwar period. Before the war, as Chart 3 shows, subscriptions to new issues were the principal vehicles for capital inflow from the United States.

This inference is drawn from the difference in industrial destination of the capital. As described further below, the investment flow since 1950 has moved predominantly into extractive industries; this was less true previously.

Between 1939 and 1952, U.S. direct investments rose by 166 per cent, to $5,000 million, or from 45 per cent to 66 per cent of total U.S. holdings. In the same period, portfolio holdings rose by only 55 per cent, to $3,355 million.

Portfolio investments, on the other hand, consist principally of bonds; in 1951 the equity element in U.S. holdings was 26 per cent.

Within manufacturing, however, there was an appreciable diversification of U.S. interests between 1926 and 1951. The wood-and-paper and iron manufactures group have attracted most capital throughout (accounting for 23 per cent of all U.S. direct investment holdings in 1952), but during and since the war manufactures of nonferrous metals and chemicals have attained a new importance.

The U.S. Government has also made advances to certain nonferrous metal mining companies since 1950.

The $150 million issue of 1948 was designed to repay emergency credits granted by the Export-Import Bank of Washington.

Previously, the existence of exchange controls had had no visible deterrent effect on U.S. investors, because securities bought after 1940 could be registered with the Canadian authorities so as to permit subsequent sale in Canada and repatriation of the proceeds.

The fact that this outflow began about six months after the heaviest part of the 1950 inflow suggests a repatriation of speculative funds, for which the incentive to realize a profit increased after six months under the provisions of the U.S. capital gains tax.

The Exchange Fund, however, entered into heavy forward sales of foreign exchange at this time.

The drop in Canadian holdings of U.S. dollars, which were permitted only in defined circumstances, was small.

The movements of private British capital were accompanied by intergovernment transactions: Canada extended an intergovernment loan of $700 million in 1942 and another of $1,185 million between 1946 and 1950. Since 1950 there have been net repayments on official loan account in each year.

There is no legislation in Canada which discriminates against foreign capital or imposes any peculiar obligation on nonresident concerns. Nonresident corporations are subject to income tax at domestic rates, currently about the same as in the United States.

See U.S. Department of Commerce, Direct Private Foreign Investments of the United States; Census of 1950 (Washington, D.C., 1953).

For equity securities, however, the speculative features of some Canadian stocks, together with the possibility of a gain from exchange rate movements, appear to have led to a bidding up of prices to a point where the dividend yield is less than on comparable U.S. stocks.

Orville John McDiarmid, Commercial Policy in the Canadian Economy (Cambridge, Mass., 1946).

Wartime trade restrictions on imports from the United States may also have influenced some investment decisions; but in view of the circumstances and the brief duration of the postwar restrictions, it is improbable that they were important.

A close offsetting of the current and long-term capital account balances is not to be expected in individual years, of course, because of movements in exports and other elements in the balance of payments.

This result is most clearly visible in the case of imports of capital goods associated with a specific investment project undertaken by a foreign concern; the same effect obtains, however, if the capital receipts are spent locally and the foreign exchange equivalent is used to finance increased imports of goods and services of all kinds resulting from a generalized expansion of domestic activity.

While these remittances have fluctuated widely from year to year as a result of changes in interest rates, corporate profits, and exchange controls, their general trend appears to have been comparable to that of the growth in external holdings.

To the extent that external indebtedness is in the form of fixed interest securities, the relative decline in investment service reflects also the typical lag of fixed charges during a period of rising prices.

It may be noted, however, that payments on equity would not necessarily fall proportionately with a decline in business profits. Between 1947 and 1951, U.S. subsidiaries (excluding branch plants), which comprise the greater part of U.S. direct investments in Canada, retained on the average almost 45 per cent of their earnings. (This is comparable to the experience of a sample of 626 Canadian companies, which reinvested about 41 per cent of their profits after tax.) This would seem to leave considerable room for profits to decline before necessitating a reduction in payments.

Investments in the export industries have the additional advantage that earnings remitted abroad are likely to vary cyclically with export receipts.

The interaction between the current account balance, the exchange rate, and short-term capital movements was described in the Fund’s Annual Report, 1968, pp. 68–70.

These are described briefly in the following section.

Without these favorable conditions, which in Canada were present to a degree such as could not be assumed elsewhere, a moderate exchange rate movement (arising from fluctuations in the balance on current account and long-term capital) might have started a cumulative movement of speculative funds that would grow to such a scale as to dominate the determination of the rate and result in intensifying rather than moderating the rate movement. The task of the Government in maintaining an orderly market might then have been greater than it would have been with an announced fixed parity.

This is not to lose sight of the fact that insofar as a capital inflow serves to finance additional imports it helps to reduce the pressure on domestic resources and is not in this context inflationary. This sequence was discussed earlier in this study. Insofar as the capital inflow is not completely offset by increased imports, however, there will be a tendency for the international reserves to rise and for an expansion of the money supply to result.

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