From time to time since the end of World War II, countries experiencing serious external payments difficulties have been able to resolve them even after the difficulties have become critical. In this series of articles, members of the Fund staff concerned with such problems describe various cricumstances in which unstable situations have been overcome and discuss the methods used.


From time to time since the end of World War II, countries experiencing serious external payments difficulties have been able to resolve them even after the difficulties have become critical. In this series of articles, members of the Fund staff concerned with such problems describe various cricumstances in which unstable situations have been overcome and discuss the methods used.

Carl P. Blackwell

During 1962, Canada was shaken by a foreign exchange crisis of extraordinary severity. The first half of that year was marked by a series of unprecedentedly large and rapid declines in official reserves. These occurred in an atmosphere of public uncertainty and confusion—compounded by a divisive national election campaign then in progress—regarding governmental intentions with respect to the exchange rate and related financial policies.

At midyear, a broad emergency stabilization program was adopted. By almost any standard, it was remarkably successful. Public confidence was quickly restored. The alarming shrinkage of reserves was arrested and reversed within a few weeks, and full recovery soon permitted progressive dismantling of the emergency program itself.

Major Background Factors

The onset of the 1962 exchange crisis in Canada grew out of public misunderstanding—both inside Canada and abroad—of the transition then in process from a freely fluctuating exchange rate to a fixed par value. The timing and phasing of this difficult transition reflected the Government’s effort, after operation under the fluctuating rate system throughout the decade ended in 1960, to use exchange rate policy as an active instrument for reducing both domestic unemployment and the current external deficit.

The fluctuating exchange rate for the Canadian dollar had been adopted in the fall of 1950 to escape powerful upward pressures upon the official exchange reserves (and the domestic cash reserves of the banking system) in the early months of the Korean War boom. It was retained for more than a decade, despite the alteration or reversal of most of the conditions originally responsible for its adoption.

In the latter 1950’s, some perverse features of the operation of the fluctuating exchange rate—and especially of its interrelationship with capital flows—became apparent. The flow of external capital into Canada continued high long after termination of the Canadian investment boom of the middle 1950’s, during a period of serious underemployment of Canada’s own manpower and capital facilities.

The large inflow of both financial capital and foreign goods and services at a time of relatively low domestic investment and slack utilization of resources was stimulated by an unfortunate combination of financial conditions during the latter 1950’s. Throughout most of the period from 1957 to 1960, despite the emergence and persistence of exceptionally large government deficits from 1958 onward, monetary expansion was held in check, so that the monetary and credit conditions maintained in Canada were more stringent, in relation to those prevailing in the United States (the principal relevant capital market abroad), than they had been in earlier years of the decade. Consequently, Canadian interest rates, both short-term and long-term, rose much further than usual above U.S. rates. With the prevailing freedom of capital movements between the two countries, an exceptionally heavy flow of U.S. funds into Canada resulted.

This additional inward movement of capital tended to keep the fluctuating exchange rate at higher levels than would otherwise have prevailed. The effects of the high exchange rate on Canadian dollar prices of exports and imports of goods and services contributed, in turn, to enlargement of the perennial import surpluses and persistence of weakness in the current account. Another source of deterioration in Canada’s international competitive position was a faster increase in her unit labor costs than in those of her principal trading partners during the early and middle 1950’s.

Remedial Measures, 1960-61

In recognition of these circumstances, the Canadian Government instituted in late 1960 and in 1961 a series of measures intended to reduce the net inflow of foreign capital, lower the exchange rate, and improve the current ex-ternal account. The improvement of the external balance was expected to contribute to a revival of domestic economic activity and employment after the business recession of 1960; and the reduction of the capital inflow was considered desirable for the purpose of retarding growth of foreign ownership and control of Canadian industry, as well as for its potential effects on the exchange rate.

Domestically, the new economic program which crystallized in the June 1961 budget included steps to bolster demand by giving financial inducements to business investment, by freeing important consumer goods from excises, and—more generally—by continuing to run a substantial cash deficit in federal transactions. Meantime, relatively easy monetary conditions were being fostered.

Externally, the main objective was substantial reduction of the net import surplus, considered inappropriate in the face of so much unemployment and unused capacity. Prime reliance was to be placed on a lowering of the exchange rate for the Canadian dollar. Basically, this was to be accomplished through policies designed to strengthen the Canadian capital market, to narrow the spreads between Canadian and U.S. interest rates, and to divert demands for funds from foreign to Canadian sources.

However, since these processes were time consuming, the Government also introduced a major alteration of exchange rate policy to hasten the decline in the rate. In June 1961, the Finance Minister declared the Government’s intention to use the official reserves for intervention in the exchange market “to ensure that the rate is kept within a range appropriate to Canada’s changing economic situation.” This meant abandonment of the long-standing policy of permitting the external value of the Canadian dollar to fluctuate freely in response to market forces.

While the Finance Minister did not indicate exactly what exchange rate (or range of rates) he had in mind, he did refer to a “significant discount” in relation to the U.S. dollar. His announcement brought an immediate decline in the exchange rate, and at the end of June 1961 it was US$0,966 per Can$1.00, compared with US$1,013 at the end of May and an average of almost US$1.03 in 1960.

Market reactions to the policy changes initiated in late 1960 and the first half of 1961 were colored then and for some time thereafter by a bitter, prolonged, and widely publicized dispute between the then incumbent Governor of the Bank of Canada and the Minister of Finance. This conflict, culminating in the Governor’s resignation in July 1961, not only did much to unsettle attitudes toward government policies within the Canadian financial community but also attracted a great deal of attention from abroad.

The Onset of the Exchange Crisis

The difficulties of managing an exchange rate without the anchor of a trusted par value, but with public knowledge of the authorities’ willingness to intervene actively in the exchange market for possibly shifting reasons, did not immediately come to the surface. For several months after June 1961, the exchange market appeared to be relatively quiet. Such market pressures as were felt tended to push the exchange rate and the official reserves upward.

Toward the end of October, apparently concerned about the possibility of speculative pressures toward a higher exchange rate, the Minister of Finance issued a public statement warning against misinterpretation of the Government’s intentions. He made it clear that the resources of the Exchange Fund would not be used to raise the value of the Canadian dollar, and suggested that “the appropriate discount” on it “might well turn out to be greater than the present 3 per cent.”

Thereafter, the movement of the exchange rate was gradually and irregularly downward for several months until after the turn of the year. Downward market pressures then became rather strong, but the exchange rate was supported by substantial use of the official reserves, reducing them from US$2,056 million at the end of 1961 to US$1,595 million on April 30, 1962. In part, this decline merely reflected seasonal influences. However, deteriorating public confidence in the Canadian dollar was also becoming a significant factor—especially during April, when both the Canadian and the interested foreign financial communities reacted unfavorably to a new Canadian Government budget projecting another large deficit.

On May 2, 1962, the Canadian Government undertook to steady the exchange market by establishing, with the concurrence of the IMF, a new par value for the Canadian dollar equivalent to US$0,925. This action apparently exerted a stabilizing influence for a few weeks, but the country was then in the middle of a heated national election campaign, and widespread uneasiness about the prospects for maintenance of the exchange rate soon dominated the market again. With public confidence ebbing, the drain on the official reserves accelerated during June. It reached intolerable proportions when the election returns on June 18 proved indecisive, leaving no party with a clear majority. From June 1 through June 24, official holdings of gold and foreign exchange were drawn down by nearly US$400 million.

The Emergency Stabilization Program

Despite the indecisiveness of the election, the resulting minority Government acted with great dispatch in dealing with the formidable exchange crisis which had come to a head during the closing weeks of the election campaign. On June 24, less than a week after the election, the Prime Minister delivered a nationwide radio-television address announcing a program of action to restore confidence and bring the exchange situation back within the guiding direction of the authorities.

The remaining reserves of roughly US$1,100 million represented only about half of the total held at the beginning of the year, and a substantial portion of these was pledged against commitments (reported at US$255 million at the end of June) made in supporting the forward exchange rate.

While the events leading up to the crisis had been peculiarly Canadian, the emergency stabilization program was almost classically orthodox. It comprised two kinds of actions: first, arrangements for massive outside financial support in immediate defense of the exchange position; and second, a set of remedial fiscal and monetary measures intended to redress the serious imbalance of exchange transactions. In announcing these actions, the Prime Minister declared the Government’s determination to defend the newly established par value, gave assurances that a climate hospitable to foreign investors would be maintained, and promised that positive, constructive, longer-term measures would be introduced later.

A central feature of the external financial support was a drawing from the Fund equivalent to US$300 million (in five European currencies). Accompanying it were reciprocal credit arrangements with the U.S. Federal Reserve System for US$250 million and with the Bank of England for US$100 million, as well as stand-by lines of credit with the U.S. Export-Import Bank for up to US$400 million. Altogether, these resources totaled US$1,050 million—more than doubling the foreign exchange resources effectively available to the Canadian authorities on June 24, 1962.

The remedial fiscal measures included reductions totaling Can$250 million a year in scheduled rates of budgetary expenditure, along with increases in revenues—estimated at the time at $200 million a year—to be derived from temporary surcharges on goods comprising about half of total Canadian imports. The improvement of the budgetary position was intended to enhance public confidence in Canadian financial management, as well as to curb net purchases of foreign goods. The import surcharges, graduated according to classes of imports and tending to induce outright increases in import costs, were expected to have a particularly direct impact on Canada’s international trade balance. (Other nations were given strong assurance, however, that the surcharges would not be retained beyond the period of need.) Another change designed to bolster the external current account was a reduction in the duty-free allowance on goods brought into the country by Canadian travelers returning from abroad.

On the monetary front, the principal action was a sharp increase of the bank rate from about 4 per cent in early June to 6 per cent on June 24. The fixing of the bank rate at that high level was followed in subsequent weeks by net sales of securities from the central bank’s portfolio in sufficient volume to bring severe pressure upon the commercial banks’ cash reserve positions. These actions were designed to raise interest rates and thus attract funds from abroad.

Early Results of the Program

Market reactions to the stabilization program were favorable and almost instantaneous. Those speculating on a fall in the exchange rate were swamped by the sheer size of the official financial resources mobilized against them, and restoration of public confidence was inspired both by the impressive display of international support for the Government’s exchange policy and by the adoption of specific fiscal and monetary measures calculated to swing the basic balance of exchange transactions toward a sustainable surplus.

Even before the end of June, recovery of foreign exchange reserves commenced. It reached substantial proportions during the next two months and proceeded almost without interruption throughout the rest of 1962 and into 1963. From October 1962 onward, Canada’s holdings of gold and foreign exchange reserves, apart from those provided through special external assistance, were actually well above the amounts held before the exchange crisis.

The first concrete result of the stabilization program was a reflux of short-term funds, but this movement was soon reinforced by a revival of net long-term capital inflows. Urgent needs for funds in the face of very tight domestic credit conditions turned Canadian borrowers toward foreign sources of financing, while the high yields prevailing in Canada furnished the necessary inducement to foreign lenders to make investments there. The tradition of freedom in both Canadian and U.S. capital markets and the absence of concern about exchange restrictions tended, of course, to facilitate and expedite the revival of long-term foreign investment in Canada. A special factor was the negotiation of a $250 million placement of long-term Canadian Government securities with a group of U.S. financial institutions. This flotation gave assurance as to the continued accessibility of the New York capital market, in addition to gaining exchange reserves directly as the securities were delivered in October 1962 and January 1963.

Relaxation of Emergency Measures

By the late summer and early fall of 1962, the Government was able to begin relaxing the more stringent of the measures applied in the heat of the midyear crisis. Three successive reductions of the bank rate, taking it back to 4 per cent by November, were accompanied by a gradual easing of the reserve positions of the commercial banks and by declines in interest rates to more normal levels throughout the spectrum of maturities.

Even before the end of 1962, the Government found it possible to carry out two stages of removals of the temporary import surcharges from some of the classes of goods originally covered. A major additional withdrawal of surcharges was announced in February 1963, and on April 1, only nine months after their imposition, all the remaining surcharges were removed. It is probably fair to say that Canada thus gained the maximum leverage from the surcharges in postponing imports while the reserve position was most strained, without incurring the longer-term hazard of dependence upon undue tariff protection for high-cost domestic industries.

Meanwhile, all the bilateral credit arrangements with the United States and the United Kingdom were either terminated or placed on a stand-by basis (in several stages) by the end of 1962. While Canada had not actually expended any of the funds available under the reciprocal currency “swaps” and other bilateral lines of credit, these arrangements had provided important contingency reserves and had undoubtedly exerted wholesome effects upon market psychology in the critical period. Canada’s drawing from the Fund remained fully outstanding for more than a year, but her net IMF position was then rapidly restored and expanded by a series of sizable repurchases, as well as through drawings of Canadian dollars by other countries. By the end of 1964, Canada had become a moderate creditor of the Fund (a position substantially enlarged in 1965.)

Effects on the Economy

Despite the turbulence injected into Canadian financial markets by the exchange crisis and the steps taken to combat it, the basic functioning of the economy was remarkably little disturbed. Production rose without interruption during 1962, arid flows of goods and services to consumers and investors increased substantially, especially by comparison with the recession-trough levels of 1961. It is true that the cyclical upswing slowed in the first half of 1962, and the approach to full utilization of available manpower and plant capacity left much to be desired throughout that year. These conditions, however, were essentially part of a larger North American economic pattern, rather than reflections of peculiarly Canadian difficulties associated with the exchange crisis. (Subsequently, the Canadian and U.S. economies both regained a stronger momentum during 1963.)

The absence of more disruptive effects upon production, employment, and incomes can be attributed to the basic suitability of the exchange rate adopted in May 1962, the brevity of the breakdown in confidence, and the speed with which it proved possible, in the aftermath of the emergency, to remove or mitigate the more constraining of the measures applied at its peak.

While the Canadian Government was anxious to reduce the current account deficit in the balance of payments, and also to curtail the accompanying inflow of foreign capital, its concern did not arise out of any particular difficulty (prior to the crisis) in financing the current import surplus. The exchange position could therefore be restored by reviving an established net aggregate of capital movements which had been suspended or postponed for special reasons. There was no need to modify suddenly the mass of Canada’s external purchases or sales of goods and services. Moreover, since an important part of the critical loss of foreign exchange reserves in the late spring of 1962 must have reflected simply the changes in “leads and lags” of commercial payments caused by great public uncertainty with respect to the exchange rate, the mere resumption of more normal timing for exchange transactions associated with daily business operations was sufficient to bring about substantial recoveries of reserves.

Fortunately, there was no justification in terms of comparative prices and costs for any strong presumption that the exchange value of the Canadian dollar would have to be lowered further. The adjustment of the exchange rate already carried out between 1960 and May 1962 was approximately sufficient to offset the greater increase of unit labor costs in Canada than in the United States which had occurred during the 1950’s. Once the authorities had dealt with the fear that sheer absence of capital inflows in the face of a current account deficit might exhaust the official exchange reserves, no ground remained for serious doubt about the sustainability of the exchange rate at US$0.925. That rate, indeed, was regarded by many observers as being somewhat on the low side in terms of comparative Canadian and foreign (especially U.S.) costs and prices.

Had it been necessary to maintain for an extended period the financial stringency imposed during the first two or three months after mid-1962, serious disturbance of business investment and other domestic spending might have developed. In the event, however, early relaxation of monetary restraint became quite feasible from the standpoint of external considerations, and no prolonged or damaging curtailment of domestic demand resulted. In the expansive North American and global environment prevailing during and following the period of Canada’s exchange difficulties, the Canadian economy continued to progress toward fuller resource utilization, aided by improvement of the current external balance not only in 1962 but also in each of the two following years.

It was fortunate for Canada that her recovery from the mid-1962 exchange crisis could take place in such a propitious international economic setting. It was also fortunate that some of the factors causing the severe reserve losses were relatively superficial and easily removable by a well-conceived attack on the problem. These considerations, however, do not detract from the accomplishments of the Canadian emergency stabilization program. Aptly designed for the circumstances in which it was adopted, it quickly restored the country’s foreign exchange reserve position, with little or no sacrifice of domestic objectives, and was expeditiously dismantled when it had served its purpose. With due allowance for the unique features of the Canadian milieu, it can be justly regarded as a model stabilization program for a confidence crisis involving a currency threatened by predominantly speculative pressures.

The Canadian experience of 1962 was of deep significance far beyond Canada’s borders. It provided a timely demonstration of the power of monetary cooperation among major nations to deal with a speculative attack upon one of their currencies, and thus became a milestone in the evolution of the present international monetary system.