Structural Adjustment


The Mulroney Government is feeding Canadians a stiff dose of the same structural adjustment medicine that the International Monetary Fund (IMF) prescribes for other debtors. Why are we being made to swallow this bitter pill?

As we first detailed in the August, 1989, issue of GATT-Fly Report, Canada is caught in a debt trap. The trap is not the national debt owed mostly to Canadians by the federal government. What ensnares us is the huge international debt owed by corporations, individuals and governments, especially the provinces and their utilities, to non-residents.

While the Finance Minister tries to focus most of our attention on the government’s deficits (the difference between annual federal revenues and spending), it is the international debt that is most threatening. By the end of 1989, Canada’s gross international indebtedness amounted to 409.8 billion. Deducting assets owned abroad by Canadians leaves us with a net international debt of $229.3 billion. It is the holders of this foreign debt, and not the Canadian people, that the Mulroney government is seeking to appease.

(Former) Finance Minister Michael Wilson has even started using the language of structural adjustment programs (SAP’s) to describe what he is doing to the Canadian economy. Consider the terms he uses in his February, 1990 budget speech: “Let’s be clear about the real source of pressure for change. It is not the government. It is the rapidly evolving and increasingly competitive world in which we must earn our way.” He then cites several “structural reforms” designed “to allow our economy and Canadians to adjust to change.”

The structural adjustments specifically mentioned in Mr. Wilson’s budget are (by now well known.) Together these measures constitute Canada’s version of a fairly typical IMF or World Bank structural adjustment program. There is one important deviation from the standard formula.

The Mulroney government has not undertaken to devalue our dollar. What makes this omission doubly puzzling is the fact that devaluation is the IMF’s standard medicine for a shrinking trade surplus and Canada’s trade surplus is slipping badly, from $19.8 billion in 1984 to only $4.7 billion in 1989.
Opposition politicians allege that the Mulroney government made a secret commitment to revalue the Canadian dollar, which means to raise its exchange rate, as one of the conditions attached to the Canada-US Free Trade Agreement (FTA).

Such a secret pact has a significant historical precedent. A former senior British civil servant, Clive Ponting, has uncovered documents from the recently declassified files of President Lyndon Johnson showing that a similar agreement was forced on the Labour government of Harold Wilson in 1965.

In addition to this British precedent, there is other evidence that the Americans leaned hard on the Mulroney government to revalue the Canadian dollar. In May of 1986, then Treasury Secretary James Baker told the US Senate Foreign Relations Committee that the price of Canadian admission to the Group of Seven industrialized countries would be to boost the value of the Canadian dollar. The ranges within which the Group of Seven pledge to keep their currencies are not made public, but they do occasionally co-ordinate interventions in currency markets.

Furthermore, while the FTA was being negotiated the powerful US National Manufacturers Association lobbied the American Treasury Secretary to use the trade agreement “to eliminate the exchange rate advantage gained by Canadian producers over their (US) counterparts in the period 1976-1986.” During the period of active negotiations, our dollar rose 14% against its American counterpart.

Whether or not a formal exchange rate pact was secretly attached to the FTA, it is clear that the Mulroney government’s actions have responded to powerful US interests. A revalued dollar makes US goods cheaper in Canada and Canadian goods more expensive in the USA. This arrangement has contributed to the dramatic fall in our trade surplus with the US from $20.4 billion in 1985 to $10.4 billion in 1989.

So long as our trade surplus withe the US falls, the Mulroney government avoids provoking an even greater number of US countervailing duties against Canada. This is because, with bilateral trade balances more favourable to US exporters, fewer US industries are inclined to launch trade actions against Canada. Mulroney is thus spared even more examples of the FTA’s failure to protect Canada from US contingency trade laws.

What keeps the Canadian dollar trading so high? Direct intervention by the Bank of Canada in world currency markets plays a minor role. Much more important are the outrageously high interest rates maintained by our central bank. Contrary to what Wilson and Bank of Canada Governor John Crow claim, the need to fight inflation is not the principal motive for keeping interest rates so high. As presented in the first graph, the inflation rate in Canada has been essentially flat at about 5% since 1983.

Nor are government deficits a significant cause of high interest rates. In fact, it is the other way around. High interest rates are the principal cause of government deficits.

Federal government revenues now exceed program expenditures by wide margins: $8.9 billion in 1989-1990 and $12.6 billion projected for 1990-1991. The chief reason federal deficits persist is that interest charges on the national debt are larger than these operating surpluses. As the second graph shows, over the last three years Canadian short-term interest rates have risen by about six percentage points. If these interest rates could be brought down, government deficits would be substantially smaller.

A US/Canada exchange rate commitment is not the only cause of our high interest rates. Even more basic is the weight of Canada’s international debt, and the returns demanded by our international creditors. During 1989, Canadians had to pay $22.4 billion more in interest and dividends to foreign holders of Canadian debt than we collected from abroad. High interest rates are the principal reason why this net drain of wealth from Canada was so large.

How were these debt payments financed? Largely by new foreign borrowing. In 1989. Canadian corporations and governments raised over $21 billion through new international bond issues. To attract investors to Canadian securities, the Bank of Canada has always kept Canadian interest rates above those prevailing in the US. But as the second graph also shows, the short-term rates spread above the US has risen sharply over the past year. It surpassed five percentage points in March of 1990.

The unusually high premium is proving costly for Canadians. High interest rates are driving down further Canada’s trade surplus, increasing federal government deficits and government cuts in social spending, raising our international debt, and triggering a domestic recession (or worse). In addition, these rates actually contribute to inflation as borrowing costs rise.

Why doesn’t the government order the Bank of Canada to set lower interest rates?

Part of the answer may by found in the experience of January this year. Bank of Canada Governor Crow did lower the bank rate at that time, from 12.43% to 12.14%, a cautious drop of less than one-half a percentage point. Foreign creditors immediately withdrew short-term loans from Canada and currency traders quickly knocked the Canadian dollar down from 85.8 cents (US) to 84.6 cents. The Bank of Canada began a reversal the following week, eventually permitting interest rates to rise to their highest level since 1982.

Governor Crow could not satisfy the demands upon Canada for foreign currency by using Canada’s foreign exchange reserves, because central bank reserves are not large enough. The pool of marketable Canadian debt held by foreign banks and corporations far outweighs the reserves held by our central bank. Without exchange controls, which the Tory government refuses to consider, the only effective way in the short run to stem capital flight is to allow interest rates to rise, especially for short-term loans.

Canada is not the only country trying to attract international credit through higher rates. Canada competes with the world’s largest debtor, the US, which must service some $600 billion in net foreign debt, as of the end of 1989. Whereas the US once led the world in setting interest rates, it must now follow the lead of others. The Wall Street Journal reports that “The (Federal Reserve Board) has lost most of its control over US interest rates. Gradually, its power is slipping away to markets in Tokyo and Frankfurt. As the Fed loses leverage,, the US is losing some of its control over its economic destiny ... America’s budget deficit and low savings rates have addicted the US to foreign capital, so foreign investors increasingly dictate the terms.”

The world’s two largest creditor nations, Japan and Germany, are currently raising interest rates for reasons of their own. Tokyo wants to combat a declining savings rate and support the yen, and Bonn on preoccupied with financing German reunification.

When so many countries compete to attract money through higher interest rates, the result is what American University economist Howard Wachtel calls a “ratchet” effect. Rates go up but not down. No country on its own can lower rates without risking large capital outflows. The competition for money leads to an ever-higher floor under interest rates.

Canada is highly vulnerable to the effects of this competition. About $70 billion of Canada’s foreign debt is “hot money” footloose capital invested in short-term Canadian bonds that will stay in Canada only as long as Canadian short-term interest rates are more attractive than elsewhere. The rate of interest paid by one country relative to another is the major indicator used by holders of hot money to decide where they will park their cash.

As Joyce Kolko has perceptively written, “Monetary questions are first and foremost power struggles.” Who then holds power in the present world of international finance?

The source of pressure on Canada and other countries to realign their domestic priorities is most often attributed to an anonymous force called “international markets.” In fact, this phrase is really an euphemism for the bond and currency trading departments of the largest transnational banks and corporations. While individuals who exchange a couple of hundred dollars for a vacation in the sun take part in international currency markets, the dominant players are the professional traders who buy and sell over US$200 billion worth of currency every day.
Only about 16% of these deals have anything to do with trade or customer accounts. Around 90% of all currency trade in handled by the currency trading departments of banks and other transnational corporations. Even the banks don’t just take orders from customers; they also speculate on their own accounts. Exxon employs more currency traders than do most countries’ central banks. In a revealing comment. British Petroleum’s director of money transactions has stated that “Our currency dealing is at least as important as our oil trading.” BP’s turnover is said to be bigger than that of the Bank of England.

It is these corporations located not only in New York, Tokyo and London, but also in Toronto, Montreal and Vancouver that Finance Ministers try to satisfy when they draw up their budgets. It is these corporations that central banks hope to satisfy in order to prevent capital outflows from their countries.

While the short-term decisions of the money and debt-trading departments of these transnationals are strongly influenced by fractional changes in interest rates, their long term investment decisions are equally important. Unlike the freewheeling days of the 1970’s and early 1980’s, these bankers and corporate money managers will now consider long-term investments only if a rigid set of policies are in place. Their criteria for appropriate trade, fiscal and monetary policies apply to Canada no less than to other debtor nations.

The chairman of the Royal Bank has summarized succinctly the kind of policies that these money managers expect from governments of debtor countries:

“Public-sector budget deficits tend to be low. Inflation rates tend to be low. Real interest rates are positive... Exchange rates are competitive. Development strategies are export-oriented and there is a high reliance on markets to allocate resources.” In short, they expect structural adjustment measures whether of not there is a formal agreement with the IMF or World Bank.

Finally, understanding structural adjustment requires that we know just who has to do the adjusting. In a major policy address, the former head of the IMF, Jacques de Larrosiere, once revealed why workers lead the list of those who are expected to do the adjusting:

“Over the last four years the rate of return on capital investment in manufacturing in the six largest industrial countries averaged only about half the rate earned during the late 1960’s.....Even allowing for cyclical factors, a clear pattern emerges of a substantial and progressive long-term decline in rates of return on capital. There may be many reasons for this. But there is no doubt that an important contributing factor is to be found in the significant increase over the past twenty years or so in the share of income being absorbed by employees.... This points to the need for a gradual reduction in the rate of increase in real wages over the medium term if we are to restore adequate investment incentives.”

In other words, structural adjustment gives priority to private capital at the expense of working people. This contrasts sharply with the priority of labour principle affirmed by the social teachings of several Christian churches in Canada.

Although the SAP’s tear at working people with greater ferocity in most Third World nations than in Canada, the high interest rates and other SAP policies that threaten the great majority of Canadians, and the suffering already demanded of the poorest sectors of our society, stem from the same global forces.

Recognizing the common roots of our oppression can bring greater strength and the more certain hope of just alternatives.

(CX5080)


See also:
Slamming the World Bank and the IMF - Activists and NGOs converge on Washington. to protest the World Bank and IMF. (CX5079).


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