– from William Krehm, Editor-Publisher Economic Reform

2/09/05

To Ms. Judy Wazylicia-Leis
Finance Critic, New Democratic Party
Parliament Buildings, Ottawa

That, indeed, was a promising opening from the party that more than any other was a dominant force leading to the nationalization the Bank of Canada that had opened its doors with 12,000 private shareholders in 1935. That nationalization enabled Canada to finance its part in the Second World War at interest rates in the 2% range. And on an ascending scale our federal government did as much as 22% of its financing with the Bank of Canada at a purely nominal interest rate in 1975. The arrangement was simple and completely transparent: as sole shareholder of the central bank, the government received the net profits of the bank’s operations as dividends. That permitted a country whose infrastructures, and public health, had sorely deteriorated under ten years of depression and six of the world war, to receive one of the greatest flock of immigrants in its history, house them, provide them with jobs, and enable Canada to repair the drop in birth-rate during the previous 16 years. And achieving all this, the federal debt as a percentage of the Gross Domestic Product declined from 146% at the end of the war to a mere 22% in 1975. Today we are clearly unable to maintain the infrastructures – material and human – that we put in place under those difficult conditions. There must be a serious enquiry of the reasons for that contradiction. Where has the money gone?

The amazing fiscal performance of those difficult years was made possible by the fact that the American banking legislation of 1935 had severely limited the banks to banking. That ruled out the wild speculations of Wall St that had contributed greatly to bringing on the Depression. That legislation had served as the model for banking law throughout much of the world. Its core provisions were to limit the interest rates banks could charge or pay, and what they could invest in. In particular, they were denied access to the other "financial pillars" each of which maintained a pool of liquid capital for the need of its own business. Allow the banks access to these reserves, and they would use them as an inverted pyramid of money creation for their own speculative ends. That in fact was what happened.

The nationalized Bank of Canada had provided the framework for the democratic financial system that the NDP desires. That framework for it is still extant in the Bank of Canada Act, set forth not only in its preamble, but in subsections 18(c), (i), and (j) that allow the central banks to hold on a roll-over basis unspecified amounts of funded and extremely generous amounts of unfunded debt of the federal and provincial governments or of any corporation guaranteed by either of these. That would not exclude our municipalities. In 1938, Bill 143 was passed by the House of Commons "to assist municipalities in making self-liquidating improvements under the name the Municipal Improvements Assistance Act, 1938. Later when the Bank of Canada had been nationalized to serve inter alia the same purpose, that act was repealed. The columns for such government debt of all levels of government are still to be found in the Bank of Canada Review, but they are like the empty pews of a deserted faith. For decades no use has been made for these facilities for which your party so prominently helped nationalize the central bank.

Surely the existence in the charter of our central bank of unused facilities for the financing of every level of our governments, but that remain unused at a time for such crying need for them, demands an explanation.

That anomaly is part of our suppressed history.

Under the Progressive-Conservative government of Brian Mulroney, an extensive campaign was conducted in our universities and the media to declare the Bank of Canada independent of the Government of Canada. That not only contradicted the contents of the Charter, but of the principles of ownership for which on other occasions our two major parties are prepared to sacrifice society itself. 12,000 shareholders had been bought out with a handsome profit after less than four years of ownership in the depths of a depression during which profits of any sort were meagre or non-existent. The nation’s ownership is attested in Subsection 17(2) of the Act: "The capital shall be divided into one hundred thousand shares, of the par value of fifty dollars each, which shall be issued to the Minister to be held by the Minister on behalf of Her Majesty in right of Canada."

Nor is there the slightest doubt about who is supposed to run the show. That is covered in subsection 14(2). "If notwithstanding the consultations provided in subsection 1, there should emerge a difference of opinion between the Minister and the Bank concerning the monetary policy to be followed, the Minister may, after consultation with the Governor and with the approval of the Governor in Council, give to the Governor a written directive concerning monetary policy, in specific terms and applicable for a specified period, and the Bank shall comply with that directive."

However, despite this clarity, under Brian Mulroney a sweeping campaign was launched in our universities and media, asserting the independence of our central bank from the Government, because it was supposedly proved "scientifically" that independent central banks are more "efficient". It was not specified efficient at what. That gospel came from the Bank for International Settlements, a purely technical organization that had been set up in 1929 to handle the syndication of the German reparation payments that the French insisted be syndicated into stronger currencies. The 1929 stock market crash interfered with that project and the BIS lingered on to render some special services to the Nazi regime. In 1938 when the German troops occupied Prague, BIS almost tripped over itself in surrendering to it gold reserves that had been entrusted to it by the Czechoslovak government.

That is why at Bretton Woods (1943) – on the initiative of some governments-in-exile – Resolution 5 was adopted calling for the dissolution of BIS at the earliest possible moment. Because of that BIS cultivated a low profile – some of its offices in Basel were actually located above a pastry shop.

The peace had brought into power social-minded governments intent on honouring the commitments made to the men in the trenches. That meant that the come-back campaign of the banks to their powers of the 1920s had to be directed to an extent not only outside but against the governments in office. There was need of a semi-underground bunker to direct that campaign, and BIS filled the bill providentially. No elected member or any official of a government other than the officials of central banks was allowed to attend its sessions. The credo of "zero inflation" that drove interest rates under Paul Volcker in the US, and John Crow in Canada into the twenty-percent range originated with BIS. Interest rates, of course, are the primary income and the gambling chips of speculative finance. Declaring the revenue and gambling chips of a potentially parasitic class the sole "blunt tool" for "licking inflation" tells you all you need know. Political power was surrendered to our banks precisely when they were being bailed out of their loss of their capital in speculations incompatible with banking.

In response to such BIS directives, under the Mulroney government, it was actually proposed not only to insert the independence of the central bank from the government but to put that and "zero inflation" into the constitution of the country. However, that proposal was turned down by the caucuses of all three major parties – including that of the government itself. And with that ominous occurrence, the government deemed it better to let sleeping dogs lie. And that is why we have a Bank of Canada Act that conflicts with just about everything that the Bank in real life does or says. It is like a local oddity, that might attract tourists like a sort of fiscal Leaning Tower of Pisa, were it not kept in the dark.

It was another act, the Bank Act, that was amended in 1991 to put an end to the statutory reserves, a portion of the deposits that the banks took in from the public that they had to deposit with the Bank of Canada. These "statutory reserves" for checking and other short-term deposits amounted to anywhere from 8 to 12 percent and for longer-term deposits less. Since the central bank pays interest on no moneys left with it – a reflection of the fact that the ancestral monarch took no profit from gold and silver he coined until he launched them into the market by spending them. The Government spent money into existence, rather than lending it into existence as banks do as a multiple of the legal tender that they retain in their coffers. But the statutory reserves also made it possible for the federal government to borrow more money from the central bank within the established limits. In the middle 1970s approximately 22% of the federal debt was held by the Bank of Canada, and the interest paid on it reverted to the government as dividends due to its position as the Bank’s sole shareholder. Even in the US where private banks own the Federal Reserve, almost the same portion of central bank income finds its way back to the government as successors to the ancestral monarch’s monopoly in the coining of precious metals. Technically, that was recognized under the name seigniorage.

The phasing out of the statutory reserves over a two-year period beginning in 1991 through an amendment of the Bank Act, ought to be of great interest to you, Ms. Wazylicia-Leis, in view of your sympathy for the rough ride small businessmen and consumers have had from high interest rates. With the end of the statutory reserves the BoC’s benchmark interest rate was left as the sole "blunt tool" to achieve the absolute flat price level that the BIS enjoined upon the world. For adjusting the statutory reserves had provided an alternate means of cooling an overheated economy. Raising those reserves meant that the banks could create less credit, and fewer projects could be financed. Their phasing out (1991-1993) established the supremacy of speculative finance over the rest of society including our manufacturing industries.

The drastic redistribution of the national income to the advantage of speculative finance has confirmed the analysis of Douglas North that such shifts in the division of the national product must lead to a collapse of the alliances that had sponsored the discontinued ones. The collapse of the Progressive Conservative Party as it existed before the deregulation of the financial sector, is in the process of being replicated within the Liberal Party that has continued the role of the Conservative party rather than reinstating the heritage of Mackenzie King.

That is why we are both puzzled and alarmed to see in your letter to Minister Goodale no mention of the necessary reinstatement of the statutory reserves.

No democratic society can be based on the recognition of manipulating interest rates as the sole way running the economy and society itself. For that leaves no room for a concern for social needs, the environment, or elementary business ethics. On a world scale it has played a key role not only in the bloody confrontation of the West with the fanatical wing of Islam, but in our carnage of the environment, including the warming of the planet which can only put many low-lying coastal cities at risk as the oceans rise. There is a lesson in the mega-disaster of New Orleans not only for parties in power, but for parties that aspire to power, and have indeed had participation in the power position thrust upon them by the disastrous dictatorship of our deregulated banks. The environment and society itself cannot be proclaimed "externalities". Unless the NDP becomes mindful of its historical role in enforcing the 1938 nationalization of the of the Bank of Canada, it will – by the logic of the Douglas North principle – be nudged out of its historic position as the leader of reformist politics in Canada.

Your letter to the Minister includes the following: "The NDP remains to be convinced of the merits of bank mergers and continues to find merger proposals wanting in their ability to demonstrate their benefit to the public. We are also realistic and recognise a Liberal or Conservative majority government is likely to usher through banking changes of little benefit to consumers, small businesses and communities."

There is much to be said for restraint and understatement, but hardly for avoiding to speak the whole grim truth when you are dealing with the suppression of the most crucial stretch of our history. That included the Depression of the 1930s that was largely brought on by the speculative orgy of banks throughout the world. The 1938 central bank nationalization in Canada – inspired by the Rooseveltian banking reform of 1935 – made possible Canada’s part in the defeat of the Nazis in the war, and then an unprecedented period of prosperity and social justice during the first three decades of the post-war period. All that was suppressed, and its very record wiped out from our textbooks, the media, and apparently the awareness of most of our legislators. But it is still in the Bank of Canada Act. That gives the NDP a tremendous weapon for repeating the feat of Tommy Douglas – and his Liberal allies – to forge the instrument that would assure us a more just society. To have brought about that original feat was immeasurably more difficult than what faces progressive forces in our day.

In your letter to the minister you go on to write, "Few benefits from Canadian banks such as the CIBC losing billions on unproven investments such as Enron, yet permitting more Enron activities is the central goal of the current merger talks."

I would suggest it is misplaced charity describing the CIBC’s involvement with Enron as an "investment." To avoid appearing in court on the matter, the CIBC settled by handing over a quarter of its capital to the prosecution. The CIBC, rather than a sleep-walking investor, had actually been the lead banker in putting together the so-called partnerships, which involved the use of derivatives to keep liabilities off Enron’s balance sheet, and directed monies to executives of the corporation. One executive and his wife were given lengthy prison sentences. CIBC’s loss was in fact considerably higher even to date than the figure you cite – in fact $US2.5 billion – with a class action and other suits pending. However, part of that was a loss that could be charged against CIBC’s Canadian tax bill. The citizens of Canada are thus contributing what would seem to be from your figure something of the order a billion US in the settlement with the US authorities. Beyond such outlandish cost, literally taken out of the mouths of our most needy citizens, Canada suffered a moral black eye as part of its reward for having disfigured its historic social system to fund our banks for a gambling career.

Not only did CIBC receive the monies to gamble with from our government by the phasing out of the statutory reserves required by the Bank Act prior to its 1991 revision, but to help bail banks in general from such heavy losses in the 1980s in gambles, the Bank for International Settlements in its Risk-Based Bank Capital Guidelines issued in 1988 proclaimed the debt of OECD countries risk-free, requiring no capital reserves for banks to acquire. This made it possible for our banks to quadruple their holdings of federal debt to $80 billion, and relieved them of having to put up with the Bank of Canada as much as 12% of the deposits they took in from the public, mostly in their chequing and other short-term accounts. In addition they were relieved of the requirement to put up statutory reserves with the Bank of Canada for some $300 billions taken into their accounts. Such statutory reserves held with the BoC earned no interest – just as coined gold and silver before it was spent into circulation by the ancestral British monarch.

Those deposits provided the means whereby the central bank could control inflation and deflation not by changing interest rates, but by instead raising or lowering the statutory reserves. By releasing those reserves to the banks, the Mulroney government left higher interest rates as the one blunt tool for "fighting inflation."

This was at a time when the Bank for International Settlements had initiated a world-wide campaign to flatten prices definitively by raising the benchmark interest rate to 14% – that meant an effective rate to businesses in the 20% area or more. That not only devastated the economy but brought down the market value of the preexistent federal debt that carried a lower coupon. In its haste to come to the aid of the distressed banks, BIS overlooked a detail. When it hoisted interest rates into the skies to "lick inflation" it devalued the hoards of bonds that the banks were allowed to load up so that might clip the coupons to replace the missing revenues from their bad investments. That occurred internationally, and led to the collapse of the Mexican currency and banking system and to the meltdown of the financial systems in Eastern Asia and Russia three years later.

When the Bank of Canada held federal debt, the interest from them ended up less handling charges with the federal government as dividends. When bonds were accumulated by the banks, the interest due on them stayed with the banks. That in fact was the essence of the bailout. That ravaged federal finances, and to adjust to it, Ottawa downloaded entire programs on the provinces without adequate funds to look after them. Eventually the provinces passed on the compliment to the municipalities which largely explains their current sorry state.

There is no way of dealing with the resulting mess without bringing into the open the entire suppressed details of the shift of much of the federal financing from its own bank, the Bank of Canada to the private banks, and immediately thereafter deregulating them for merging with the other "financial pillars" – the stock market, insurance companies, and mortgage corporations. Each of these maintained a liquidity pool for its own business, and once the banks were given access to these through merger with these other financial pillars, the banks has used that as money bases for compounded stacked credit creation. The ratio of bank assets to legal tender in their vaults and on deposit with the Bank of Canada that had been approximately 11:1 in 1946, is currently just under 400:1 and those assets are booked at their historic rather than current value. With all due respect, you have no way of forming a meaningful opinion on the subject of bank mergers, unless you are acquainted with the cut of history that I have mentioned, or the consequences of bank deregulation that made possible the previous mergers of our financial institutions.

You have a heavy responsibility to insist on a return of the Bank of Canada to the functions for which it was nationalized and are still substantially to be found in its Charter. COMER is ready to assist in helping you acquaint yourself with this vital suppressed history.

With my best wishes,

William Krehm
Editor of Economic Reform

– from Economic Reform, October 2005