Shortly after the imposition of exchange controls in 1939 and the official fixing of the Canadian dollar’s value in terms of the U.S. dollar by the FECB, an unofficial market for Canadian dollars developed in New York that persisted until the Canadian dollar was floated at the end of September 1950. This was a legal market involving transactions in Canadian dollars between nonresidents of Canada. Residents of Canada were prohibited from acquiring foreign exchange through the unofficial market. Similarly, no resident of Canada was ever authorized to convert foreign exchange into Canadian dollars through the unofficial market.
The source of "inconvertible” Canadian dollars consisted of Canadian-dollar bank balances held by non-residents when exchange controls were introduced in 1939, sales by U.S. residents of certain types of assets (such as real estate), and the proceeds of maturing Canadian-dollar securities paid to non-residents.
Canadian dollars purchased in the unofficial market could be used only in a very circumscribed manner. For example, they could not be used to purchase Canadian goods and services. In this regard, the purpose of exchange controls was not just to conserve available foreign exchange but also to maximize the receipt of foreign exchange. U.S. residents wishing to buy Canadian securities or real estate were, however, permitted to use Canadian dollars obtained in the unofficial market, as could travellers to Canada.
The unofficial market for Canadian dollars ended with the floating of the Canadian dollar. Throughout most of its existence, the inconvertible Canadian dollar traded at a sizable discount compared with its official counterpart (Chart 4). The spread between the two rates mirrored the pressures on the Canadian economy, widening to more than 10 per cent during the darkest months of 1940 and narrowing as the war progressed and Canadian prospects improved. By 1945, the discount was temporarily eliminated. Indeed, for a few months during 1946, prior to the upward revaluation of the official Canadian dollar back to parity with its U.S. counterpart, the inconvertible Canadian dollar traded at a slight premium in the free market.
Canadian Dollar in Terms of the U.S. Dollar
Monthly averages (1939–50)
1. September 1939: War is declared, the Canadian dollar is fixed, and
exchange controls are imposed.
2. September 1945: World War II ends.
3. July 1946: Canadian dollar revalued.
4. November 1947: Exchange controls tightened.
5. September 1949: Canadian dollar devalued.
Interestingly, when the official rate was finally revalued on 5 July 1946, the inconvertible Canadian dollar, while also appreciating, did not move up the whole amount. It g enerally traded between US$0.95 and US$0.96 through the remainder of that year. Clearly, the revaluation was not viewed as completely credible by free-market participants. Indeed, the free rate slowly weakened over the next few years, foreshadowing the eventual devaluation of the official rate in September 1949.
The inconvertible Canadian dollar declined with the devaluation of the official exchange rate in 1949, but to a lesser extent, temporarily eliminating the differential between the two rates. With the inconvertible Canadian dollar continuing to weaken to about US$0.8840 through the winter of 1949–50, a differential of roughly 2.5 per cent temporarily re-emerged. The sudden improvement in Canada’s economic prospects, however, and strong capital inflows from the United States, eliminated the differential between the two rates once again by March 1950. Indeed, the unofficial rate actually moved to a marginal premium to the official rate immediately prior to the decision to float the Canadian dollar.