By mid-1950, the depreciation of the Canadian dollar against its U.S. counterpart the previous year, combined with rising commodity prices associated with the beginning of the Korean War in June 1950, had significantly strengthened Canada’s trade balance with the United States. At the same time, the economic recovery in Europe, aided by the Marshall Plan, which provided European countries with convertible U.S. dollars, boosted Canadian exports. There were also strong inflows of direct investment into Canada. Short-term capital inflows also increased sharply, particularly through the third quarter of 1950, as speculation regarding a Canadian-dollar revaluation intensified.
(Poster for Canada Savings Bond campaign, ca. 1950)
In this environment, Canadian authorities became increasingly concerned about the inflationary impact of the inflows if Canada tried to maintain a fixed exchange rate. There was also concern that the inflows were leading to a "substantial and involuntary increase in Canada’s gross foreign debt” (FECB 1950, 14).
On 30 September 1950, Douglas Abbott, the Minister of Finance, announced that
Today the Government, by Order in Council under the authority of the Foreign Exchange Control Act, cancelled the official rates of exchange which had been in effect since September 19th of last year . . . . It has been decided not to establish any new fixed parity for the Canadian dollar at this time, nor to prescribe any new official fixed rates of exchange. Instead, rates of exchange will be determined by conditions of supply and demand for foreign currencies in Canada.
He also announced that any remaining import prohibitions and quota restrictions, imposed in November 1947, would be eliminated, effective 2 January 1951. Controls on imports of capital goods were also to be reviewed.
Interestingly, the idea of floating the Canadian dollar was widely discussed as early as the beginning of 1949. A then-secret memorandum prepared in January of that year by James Coyne, then Deputy Governor of the Bank of Canada, made the case for floating the currency while retaining exchange controls. In his paper, Coyne noted that it would be better to "have a natural rate which could move up or down from time to time as economic conditions might require.” He also noted that government inertia made it very difficult for the authorities to adjust a fixed exchange rate in a timely manner.
Options other than floating the exchange rate were apparently dismissed as impractical, including revaluing the Canadian dollar upwards, widening the currency’s permitted ±1 per cent fluctuation band, or restricting capital inflows. Given the criticism levelled against the government after the 1946 revaluation of the Canadian dollar, followed by the short-lived 1949 devaluation, another revaluation was viewed as unacceptable. It was also unclear how much of a revaluation would be required to stem the capital inflows. Widening the bands also posed problems, since it was unclear how wide the bands would have to be. Likewise, restrictions on capital inflows were seen as untenable from a longer-term perspective for a country dependent on foreign capital.
This view is consistent with a speech on exchange controls given by Douglas Abbott, Minister of Finance, in December 1951,
The conclusion I have come to is that we would be better advised not to rely on exchange restrictions, but rather on the general handling of our domestic economic situation to keep us in reasonable balance with the outside world and to maintain the Canadian dollar over the years at an appropriate relationship with foreign currencies.
(Bank of Canada, $10, 1954 series
This was the first note series to feature Canadian landscapes. These notes were simpler in design and more modern in style. This was also the only series to feature the reigning monarch on each denomination. This was popularly known as the "devil’s head” series because of the image discernible in the Queen’s hair.)
The system envisaged by Coyne in 1949 of a floating Canadian dollar within a system of foreign exchange controls was put into practice when markets opened on 2 October 1950. With interbank trading now permitted, the Canadian dollar quickly appreciated, rising five cents to roughly US$0.95.
With the floating of the Canadian dollar, the rationale for the continuation of exchange controls came into question. Through 1951, controls were progressively eased. Finally, on 14 December 1951, the Foreign Exchange Control Regulations were revoked by an Order-in-Council. New regulations were passed that exempted all persons and all transactions from the need for permits to buy and sell foreign exchange. The Foreign Exchange Control Act itself, which had been renewed for another two-year period earlier in 1951, was repealed in October 1952.
After a quick rise to the US$0.95 level immediately after the float (Chart 5), the Canadian dollar continued to appreciate at a more gentle pace, moving to a small premium of about 2 per cent vis-à-vis the U.S. dollar by 1952. From then until the end of 1960, it traded in a relatively narrow range between US$1.02 and US$1.06. The peak for the Canadian dollar during this period was US$1.0614, touched on 20 August 1957. Foreign exchange intervention by the Bank of Canada through the Exchange Fund Account was limited to smoothing short-run fluctuations of the Canadian dollar.
Canadian Dollar in Terms of the U.S. Dollar
Monthly averages (1950–62)
* 20 August 1957: Modern-day Canadian-dollar peak: US$1.0614
1. September 1950: Canadian dollar floated
2. December 1951: Exchange controls lifted
3. May 1962: Canadian dollar fixed
While generally unpopular in business circles, the floating exchange rate was supported by many academic economists as a means of insulating the domestic economy from external shocks, either inflationary or deflationary. It was also recognized that the two-way risk associated with a flexible exchange rate could itself lessen large capital movements.
Canada’s successful experiment with a flexible exchange rate regime through much of the 1950s inspired considerable early academic work on the merits of a flexible exchange rate system. Later, it would provide a model for the rest of the world when the Bretton Woods system of fixed exchange rates finally collapsed during the early 1970s.