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Aspects of Speculation in the Canadian Market for Foreign Exchange*
Published online by Cambridge University Press: 07 November 2014
Extract
Since the fourth quarter of 1950 the Canadian dollar has been allowed to find its price in terms of foreign currencies, usually with little official interference. During this period special interest groups have occasionally complained about the level of the rate of exchange, but, on the whole, the operation of the new system of exchange has met with satisfaction at home and admiration abroad. This success has depended on the small amplitude of the fluctuations that have taken place in the rate of exchange during short periods of time, say quarter to quarter. However, very little is known about the mechanism that has operated to maintain such stability as the rate has shown in practice. Confidence in the future stability of the rate can easily be mistaken under these circumstances. It is the purpose of this paper to shed some light on the equilibrating process in the market in foreign exchange by identifying the stabilizing influences in the balance of payment and by developing a possible explanation of their movement.
The items in the balance of international payments can be divided into two categories according to the manner in which they are related to the rate of exchange if it is assumed that they have demand and supply functions that are independent of each other and that they have ordinary Marshallian elasticities. The appropriate assumptions about other things to be held constant when analysing merchandise trade, for instance, include income and its distribution, relative prices, tastes, and production functions. The things held constant do not include other items in the international accounts such as movements of capital from which come the offsetting net supply or demand for foreign exchange. Some of the items are not independent: freight and shipping are obviously related to trade; but the smaller items are not taken up separately in this analysis.
- Type
- Research Article
- Information
- Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 24 , Issue 3 , August 1958 , pp. 355 - 372
- Copyright
- Copyright © Canadian Political Science Association 1958
Footnotes
*
I should like to express my thanks for information and advice to the large number of business men and public servants whom I consulted while preparing this paper. Mr. E. B. Carty of the Dominion Bureau of Statistics was especially helpful. None of them is responsible for my views. My research was financed by the Rockefeller Grant for Research in the Economic, Political and Social Development of Canada at the University of Toronto and also by the Institute for Economic Research at Queen's University.
References
1 The assumption is that the price elasticities of demand for imports and exports of merchandise are not so low as to render that item unstable. Such low elasticities are unlikely because most Canadian imports and exports compete with domestic and foreign industries and are a small proportion of total domestic and foreign consumption. Slater, David W., “The Growth and Structure of Canadian Imports, 1926–1955,” unpublished Ph.D. dissertation, University of Chicago, 1955, 104–20.Google Scholar
Misinterpretation of a negative correlation would also arise for a number of other unlikely reasons. One such is that if changes in the rate of exchange coincide with changes in the general level of prices in the same direction when a deficit in merchandise trade exists, changes in the value of the deficit would be consistent with changes in its volume in the opposite direction. This possibly of misinterpretation is inapplicable to the present case where the coefficient of correlation between the price of the United States dollar and the Consumers' Price Index is −.28 for the period from the last quarter of 1950 to the last quarter of 1956.
2 The change in height of curve IV is equal to the area under curve III.
3 Eastman, Harry C. and Stykolt, Stefan, “Exchange Stabilization in Canada, 1950–4,” this Journal, XXII, no. 2, 05, 1956, 221.Google Scholar Where the speculator has monopoly power, the solution is somewhat less clear-cut. See Eastman and Stykolt, “Exchange Stabilization Further Considered,” ibid., XXIII, no. 3, Aug., 1957, 404–8.
4 Dominion Bureau of Statistics, The Canadian Balance of International Payments, various issues, and Sales and Purchases of Securities between Canada and Other Countries, various issues.
5 Balance on merchandise trade, −.18; balance on other current account transactions, .07; net direct investment, −.33; net new issues, −.08; net trade in outstanding Canadian stocks, −.37; net loans by government of Canada, .02; changes in Canadian dollar holdings of foreigners, −.49; net trade in outstanding issues of Canadian bonds and debentures, .34; changes in official holdings of gold and foreign exchange, .22; and “Other capital movements,” .30.
6 A sum of $334 million was offset by changes in official holdings of gold and foreign exchange and $315 million by trade in outstanding Canadian bonds. For the entire period of twenty-five quarters following October 1, 1950, the cumulative gap in the autonomous balance was $2,981 million and it was offset by “Other capital movements” of $1,667 million, changes in official holdings of gold and foreign exchange of $835 million, and trade in outstanding Canadian bonds of $479 million. In those quarters in which one of the “equilibrating” items was moving with rather than against the autonomous balance, it was subtracted from the other two equilibrating items in proportion to the size of the latter. If two equilibrating items had the same sign as the autonomous balance, they were subtracted from the third.
7 Dominion Bureau of Statistics, Canadian Balance of International Payments, annual issues.
8 Ibid., 1956, 27, contains a chart which shows the item “Other capital movements” and its component “changes in loans and accounts receivable and payable and other transactions” on a quarterly basis, 1954 to the first quarter of 1957.
9 The coefficient of correlation between changes in the autonomous balance and “Other capital movements” is −.83 for both the eighteen and the twenty-five quarter periods.
10 Eastman, and Stykolt, , “Exchange Stabilization in Canada, 1950–4,” 228.Google Scholar
11 The forward exchange parities are the premia or discounts from the spot rate equal to the difference between interest rates in two centres. Different parities are obtained by the use of rates on different investments. The choice of appropriate rates depends on the problem at hand. The weighted average of tender rates on three-months Treasury bills is used here.
12 Bank of Canada, Statistical Summary, Financial Supplements, 1955, 52.Google Scholar
13 Eastman, and Stykolt, , “Exchange Stabilization in Canada, 1950–4,” 230.Google Scholar
14 Since this is the rate at which a purchase or sale automatically made near the noon-hour by the Bank of Canada is effected, it does not set a standard of skill in dealing in foreign exchange that should be difficult to equal over a number of transactions.
15 Dominion Bureau of Statistics, Canadian Balance of International Payments, 1955, 25–6.Google Scholar
16 Though a substantial part of Canada's current account transactions and some capital transactions are with countries other than the United States, most are made through the intermediary of the United States dollar. The absence of uneven cross rates of exchange and the dominance of the United States dollar in transactions in foreign currencies has permitted the analysis in this paper to be carried out exclusively in terms of that currency.
17 Economist (London), CLXXV, 06 4, 1955, 867–8.Google Scholar
18 Depending on the terms of the purchase, the actual movement of capital need not coincide with that shown in the statistics. For instance, in the cases in which goods become the property of the purchaser when they are shipped by the seller, the actual loan is made at an earlier date than appears in official statistics. Some days may elapse between the shipment and the movement of goods through the customs ports at the frontier where they are recorded and more time elapses before the relevant customs forms are received by the Bureau of Statistics which records the trade for any calendar period according to the date on which it receives the documents.
19 No method of estimating the volume of forward transactions in Canadian dollars exists. Some transactions are paired off on the books of banks in Canada and abroad, some are made between Canadian banks and firms and foreign banks and firms, and some are made between Canadian banks. Only the latter are carried out by the foreign exchange brokers of the Canadian Bankers' Association and a record is collected which, however, is not available to the public.
20 This relationship is not a necessary one because both categories exclude the two other equilibrating items: changes in official holdings of gold and foreign exchange and net trade in outstanding issues of Canadian bonds and debentures.
21 The United States Treasury Bulletin publishes monthly figures for holdings of short-term (i.e. twelve months and less) United States dollar assets by Canadians. This amount is divided into “Business and Individuals” and “Government and Banks.” For the purposes of analysis in this paper it is necessary to exclude assets owned by the Dominion government. This cannot be done by subtracting official reserves from the second group because the Canadian government holds United States Treasury notes ( Bank of Canada, Statistical Summary, Financial Supplement, 1956, 66 Google Scholar). Until September, 1955, another series appeared in the United States Treasury Bulletin showing quarterly Canadian holdings of securities with original maturities of twelve to twenty months. If these securities are assumed to be official Canadian holdings, as is suggested by the large sums rolled over, they can be added to “Government and Banks” from which “Total Official United States Dollar Spot Holdings” ( Bank of Canada, Statistical Summary, Financial Supplement, 1956, 66 Google Scholar) can be subtracted to leave holdings presumably of Canadian banks. This method of calculation is not applicable to the period following September, 1955, when the series for securities with original maturities of up to twenty months was discontinued. For the later period, official holdings of longer-term securities were estimated by subtracting $100 million from the United States Treasury series “United States Government Bonds and Notes Held by Canadians” and using the remainder. Unofficial holdings of United States government bonds and notes were estimated to be approximately $100 million for the period from 1951 to September, 1955, by subtracting the estimate of Canadian official holdings of longer-term securities from “United States Government Bonds and Notes Held by Canadians.”
22 The data presented in Figure 4 differ in their annual movement from the item in Dominion Bureau of Statistics, Canadian Balance of International Payments, “Other capital movements, Bank balances and other short-term funds abroad,” because the D.B.S. item includes deposits in other currencies and excludes assets of foreign banks in Canada. The Dominion Bureau of Statistics series is not published on a quarterly basis.
23 Cf. Minsky, Hyman P., “Central Banking and Money Market Changes,” Quarterly Journal of Economics, LXXI, no. 2, 05, 1957, 186.Google Scholar
24 Lavington, F., The English Capital Market (London, 1921), 230.Google Scholar