Whitehouse’s Sitting Ducks
William Krehm
Simon Whitehouse is to be congratulated on the sitting academic ducks he has assembled in getting responses to the economic program of the Canadian Action Party. It is on rare occasions that academics, keenly aware of what has become necessary to earn and maintain tenure in the economics departments of our universities, will put their wisdom on the line.
“Stanley Winer – Canada Research Professor in Public Policy, School of Public Policy and Administration, and Department of Economics. If you tell the chartered banks to hand over a portion of their deposits and pay no interest on them, this is potentially a source of funds for the government. However, I doubt if this is a good idea. The banks already pay income tax. Why single out the wealth of their shareholders in this way? There are better ways to change tax structure.”
What Professor Winer is saying, though he may not be aware of it, is that history itself is a bad idea. Undoubtedly that is why so little economic history – even that as recent as the 1970s, not to say of the Great Depression – is taught in our universities. Yet the importance of our central bank having interest-free redeposits of a modest portion of the deposits taken in by the banks from the public exceeds by far its “taxing” functions. (It used to be 8 to 12% for chequing accounts and much less for accounts requiring notice before deposits being withdrawn.) Quite apart from its purpose in assuring that the banks can meet the claims of their depositors (backed, be it never forgotten, by the role of the government via its central bank as “lender of the last resort”) it has yet other functions that hark back to the Middle Ages. Then the monarch’s power depended on his having a monopoly in the coining of precious metals. Where that monopoly was absent or weak with local feudal lords sharing that coining power with the monarch, central power was feeble as in France and Germany. Where it was clearly established, the central power thrived as in England under the Anglo-Saxons. There it was even taken over intact by the Norman conquerors. That is why that power today – where it still exists – is known as seigniorage. He who possessed that monopoly power was indeed a monarch. Where he shared it with petty lords throughout the land, he was at best a sad pretence of one.
Far more than a “tax,” it places in the hands of the government the economic power to enforce whatever distribution of power Parliament may decide. During the depth of the Depression of the 1930s, which was brought on by the speculative excesses of the banks, thousands of American banks closed their doors. Under Roosevelt in 1935, the Bank Act was passed and became the model throughout the non-Communist world. It was based on a few simple principles.
Is History not a Good Idea?
You will find what Professor Winer considers “not a good idea” explained in any university text book on economics used in Canadian universities prior to 1991, and in none published since then. 1991 was the fateful year when our banks, having lost – as a group – nearly or more than all their capital – were bailed out by the government doing away with the statutory reserves. The most commercially successful of all best-sellers among economic texts – Economics by Paul A. Samuelson (Canadian edition prepared by Anthony Scott, McGraw-Hill, 1967) explains some of the purposes of the statutory reserves that banks had to put up with the central bank on an interest-free basis in Chapter 16, beginning on page 319. Nobody in 1967 would pass an economics test who argued that the statutory reserves were just a form of “taxation.” Anybody who didn’t adopt that dogma today would find it hard getting a PhD at most universities.
The two main policy tools for directing the economy through the money supply were: (1) the central bank set the benchmark interest rate known as the “bank rate” in Canada and the “fund rate” in the US. This is the rate that one commercial bank charges another for a strictly overnight loan to meet its obligations vis-a-vis the central bank. This influences the whole gamut of interest rates right through mortgages, credit cards or whatever. (2) The statutory reserves. When the economy was overheated with too much demand and not enough supply, the statutory demands would be raised, say from their average of across the board of five percent to six. If the economy were depressed, the reserves would be lowered. That left the commercial banks more leverage in applying the “banking multiplier,” lending out – as a system – many times the cash in their vaults or on deposit with the Bank of Canada.
However, when interest rates were raised it hit everything that moved or stood still in the economy. The use of the statutory reserves, on the other hand, could be better targeted at those contributing to an overheated or recessed economy.
When our banks had lost much or all of their capital in the 1980s in speculative plays, the loss was made good in two principal ways. In 1988, the Bank for International Settlements (BIS), a purely technical bunker of central bankers, declared the debt of developed countries risk-free and thus requiring no down payment for banks to acquire. All they had to do was clip coupons and they were in funds again. If we adopted Prof. Winer’s terminology about the interest-free reserves that banks used to put up with the central bank, we would have to term it a “tax on the government” levied on behalf of the banks. That enabled Canada’s banks to quadruple their holdings of Canadian government bonds from 20 billion dollars to eighty billion without putting up a dime.
That also left higher interest rates the only means of combating higher price indexes, which were taken to be synonymous with “inflation.” Inflation, properly understood, refers to higher prices resulting from too much demand and not enough supply to meet it. But prices can go up for very different reasons – “structural” ones. During the first three decades of the postwar, Canada was transformed from the semi-rural country that it was before World War II to a highly industrialized one. New technologies that required much higher standards of education, rapid urbanization that called for all sorts of costly infrastructure like subways, far more public investment was needed. Not even an economist moving from a small town to New York City expects his living costs to stay the same. How then could it possibly do so when society itself makes such a transition? For to provide these public services, requires a higher layer of taxation in the price level. Try suppressing that to make the price index flat, and you merely add to that layer of taxation in price, by depressing the private sector. Use higher interest rates as the one means as “the one blunt tool” for achieving this, and you surrender power to the bankers, for interest is their basic revenue, and mobile interest rates their gaming dice. For the banks’ were not only bailed out of their gaming losses in the 1980s, but deregulated further to be able to gamble better on a bigger and more embracing scale. And what paid for the banks’ losses in this expanding casino became was the welfare of every family in the land. That is precisely what happened in 1991 when the alternative to raising the benchmark interest rate – raising the statutory reserves – was abolished.
In addition to ignoring history, the official economists impede the task of future historians by suppressing the records of their own disasters. For example in their surrender of our economy to speculative finance they committed booboos of incredible incompetence, but covered them up so completely that society seems condemned to repeat them again and again. Over the past forty years, the Bank for International Settlements served as a sort of war room for the campaign to bring back the banks to the command of the economy, a state of affairs that produced the 1929 crash and the subsequent decade of depression that led to the Second World War. Thus at the same time as under the aegis of the BIS, the debt of central governments of the developed nations was declared risk-free requiring no additional capital to acquire, the BIS directed a world campaign for the central banks to achieve a flat price level (“zero inflation”) with the one remaining “blunt tool,” thus pushing up interest rates to accomplish that goal. What they overlooked was these two goals were incompatible. For when interest rates go higher to wipe out every vestige of “inflation,” the market value of the banks’ preexistent bond-hoards must take a dive as new bond issues with higher coupons are issued at par. The crash first occurred in Mexico in December 1994. where American advisers had imposed the North American Free Trade Treaty that ruled out any hindrance to the free movement of currencies across frontiers, and brought in government bonds convertible into US currency (“tesobonos”). The result brought down the Mexican banking system, and only the largest standby fund hastily organized on US initiative with the participation of the International Monetary Fund and Canada prevented if from bringing on the crash of the world financial system.
The consequences of the banking lobby taking over economic policy were far-reaching though apparently beyond the ken of Professor Winer. President Clinton’s Secretary of the Treasury, Robert Rubin, an astute alumnus of Wall St., concluded that the days of sky-high interest rates were over. Instead Secretary Rubin introduced by stealth capital budgeting (also known as “accrual accountancy”) that had existed from time immemorial in the private sector. Though much had been made of the “deficit,” it was in fact largely the result of execrable bookkeeping.
Government Accountancy would have Put a Private CEO in Jail
That in the private sector would put both the corporations executives and their accountants in jail. Up to then when governments in Canada, the US, the UK and most parts of the world made a capital investment that would last for many years – a building, a bridge, a highway, it would be treated as a current expenditure and written off as though it were completely used up in the year of its completion.
This non-accountancy showed a vast deficit that was not necessarily there. Even the attempt to balance such a budget led to more taxation than was strictly necessary – like paying off the mortgage on your home in a single year.
Then since the capital asset appeared on the government books thereafter at a token dollar, it could be privatized at a small fraction of its real value, and still show a sturdy profit to the government. This could be applied to “reduce the debt.” That allowed the government to take a deep bow for its “fiscal prudence.” The privatized asset, moreover, would be organized as a public company promoted with a good profit to the promoters as the taxpayers who had already paid for it once in taxes now had to pay for it in users’ fees a second time.
In the Roosevelt Bank Act of 1935 firewalls had been established between the banks and the other financial pillars – insurance, real estate mortgages and stock markets. There was a reason for that. Each of these other pillars maintains a pool of liquid capital for the needs of its own business. Allow the banks to lay hands on these cash pools and banks will apply to them in sequence the “banking multiplier.” What results is a skyscraper of speculation with the total bank cash serving in turn as the denominator of its credit or “near-money” production. Economists call interest-bearing debt “near money” because every time the benchmark central bank rate goes up the market value of the pre-existing debt drops, since the interest it pays is less than that of new debt. It thus lacks one of the attributes of true money – a relative independence vis-a-vis movements of interest rates.
Let us move on to the contribution of Dane Rowlands, associate professor and associate Director of the Norman Paterson School of International Affairs. Professor Rowlands had this to say of Mr. White-house’s effort: “What the person is suggesting is the creation of new money to fund government programs. In general all economists (with a few fringe exceptions) view this sort of suggestion as simplistic at best and disastrous at worst.” Really reducing the issues to the counting of academic noses is hardly in place when so many heads have rolled throughout academe, and celebrities of yesteryears are not even mentioned in economic courses today.
“The idea that money is wealth harkens back to the old Social Credit Party and is generally regarded as symptomatic of wishful, but weak thinking.” That is exactly the opposite of what John Maynard Keynes acknowledged learning from the writings of the founder of Social Credit, Major Douglas. But the advantage of wiping out history is that you can reconstruct it to your fancy. Professor Rowlands goes on to say: “It is true that such a policy could have some beneficial effects if the economy were operating in a depression or with significant under-utilized resources, as it was in the 1930s, That is not the case now, and the idea of expanding the money supply, which is what this person is suggesting, would do very little except create inflation.” But the 6.1% unemployment of which the US is so proud does not include the ever growing population in its penitentiaries, its armies in Iraq, its war industries, the homeless, the millions engaged in marginal employments such as annoying their fellow citizens during dinner hour with telemarketing, or the imminent bankruptcy of its three Big Three auto firms, with the mass disappearance of pensions that had served rather than higher wages to pay labour in many key industries. Nor the detail that the gap between the wealthy financial touts who deal not even in stocks and bonds, but in the abstract concept of “risk.” with their winnings, however, going to swell the proud GDP, as have the disasters of neglect such as New Orleans. As for the “beneficial effects of Social Credit if the economy were operating...with significant under-utilized resources,” as it was in the 1930s.” It is amazing that the professor has failed to notice that even the hurricane of New Orleans has had some “Keynesian effect” in reviving our sagging overblown stock markets. And if levees needed to protect undersea sections of major cities are not provided that should be noted as a capital deficit rather than as prudent fiscal policy before the disaster. The professor himself comes to serve as a prime exhibit of the guarantee of disaster that economic theory as taught in our universities has become.
Helping Our Government Catch Up with Double-entry Bookkeeping
“Such a policy that this person is suggestion would do very little except create inflation.” The very word “inflation” which for decades – despite the preamble of the charter of the Bank of Canada – has become the sole concern of our central bank is misleading, since it assumes the possibility let alone the need for a flat price index in a society undergoing population, technological revolutions, urbanization, increased life spans on most continents. Moreover the absence of accrual accountancy in all government investments until 2000 in Canada, and still in human investments, leaves us flying blind on what the real state of the government budget might be. “The mechanics the person suggests are also not really correct. The budget would not be balanced, as the fiscal balance is tax revenue less government expenditures.” This is not so, there is another important factor – double entry bookkeeping that the Crusaders brought back from the Arab lands in the 13th century or so. Today that requires accrual accountancy that COMER had been advocating for decades. As did two Royal Commissions and a long list of Auditors-General. However, until the 1960s, human investment had not been included in the capital concept. For introducing the view that human capital is the most productive investment a nation can make, Theodore Schultz was awarded the Nobel Prize for Economics in the 1960s, but who but CAP-COMER mentions this today? And even on the Accrual accounting of physical investments of government which the government finally adopted in 1999, when the then Auditor-General, Denis Desautels refused unconditional approval of two successive balance sheets of the government until it were done. Such has been the dumbing-down of Parliament, economists, and the electorate in the interests of our ever more freely gambling banks. Without the freedom of information, democracy is a sham.
“If individuals lend the government money by, say buying Canada Savings Bonds, they have less money to spend themselves and the stimulative effect would disappear unless they themselves borrowed. If they did it would lead to an increase in aggregate demand, but it is not clear that the demand would be translated into significantly higher output. There is a higher probability that it would lead to price increases, since it is not clear how much more output can be squeezed out of the Canadian economy at the moment.”
Our history – of a period when the banks were kept strictly to banking – of the postwar 25 years should be the primer for evaluating such uncertainties. At the end of the war, the national debt amounted to some 150% of the Gross National Product. Over the next three decades, Canada caught up with the neglect of its infrastructures during 10 years of Depression and six of war, introduced new technologies, assimilated a vast and most penniless immigration, transformed itself from a semi-rural to highly industrialized nation, and yet the ratio of its national debt to GNP was reduced from 150% of the GNP to under 72% (of the GDP). And at that the physical and human investment of government was wholly ignored on the federal level, and also in the case of most of the provinces. Obviously the professor would have been better advised to concentrate on the “cooking of the government books” of which Auditor-General Desautels accused Prime Minister Martin in 1999, rather than to advance the highly nonsensical theory that the government cannot use its own bank to do at least its financing of essential capital projects. Instead they hold that Ottawa can only borrow from the chartered banks that it so recently bailed out from their speculative splurges. And to top it all the deep deficit left by the end of reserves and the declaration of the debt of risk of the central governments of developed countries as “risk free” That permitted our banks to stock up with federal debt without putting up a dollar of their own. Naturally that left a deep hole in the federal budget since their borrowing – up to 22% of their budget by the mid-1970s. What had cost them practically nothing when done through their own bank, the Bank of Canada, now cost them an immense amount of money, especially since the same Bank for International Settlements had pushed interest rates into the skies to “lick inflation.” And that is why in the same year that the reserves began to be phased out, 1991, the GST tax was introduced.
It is amusing to read the professor’s statement: “If the government borrows from the Bank of Canada it essentially amounts to printing money, creating inflation and taxing ‘money balances’ of assets with a nominal valuation. The only scenario by which such a policy would have real beneficial effects would be if it stimulated the economy to produce more. Under current capacity constraints and according to all the evidence I have seen, this is highly unlikely to occur to any measurable degree under current circumstances. Canada has its lowest unemployment rate in 30 years, and the gap between that level and full employment is almost entirely due to regional and structural rigidities that are slowing down the transfer of labour and other resources from lagging regions and sectors to growing ones.” The trouble is that with the first call on the nation’s resources reserved for the deregulated financial sector, essential sectors such as education, health, environmental conservation are deprived of resources which are lavished on the banks.
Randall Germain – Associate Professor of Political Science, Carleton University, had this to say: “For my part, I rather doubt the numbers involved here, and not just because would involve rewriting the Bank Act and reducing the technical independence of the Bank. There is a debate about whether such independence is good or bad, but the bottom line is that it requires legislative change to implement.” Is this to mean that the legislature that we will be electing has not the power to undo what was never debated in Parliament, but slipped through as though by thieves in the night? At the moment the Bank of Canada Act asserts loud and unequivocally that the Bank of Canada is not “independent” of the Government. The 12,000 shareholders were bought out by the federal government at a good profit (rare phenomenon during the 1930s). The position of the federal government as sole shareholder is set forth in Subsection 17(2) of the Act.
In Subsection 14(2) it is established that if “there should emerge a difference of opinion between the Minister [of Finance] and the Bank concerning the monetary policy to be followed, the Minister May, after consultation with the Governor and with the Governor 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.”
18(c) establishes that the Bank may buy and sell securities issued or guaranteed by Canada or any province. That would cover the provinces, but the interest on such securities would not revert to the provinces as dividends since they are not shareholders, but to the federal government. Since the cost of the bank bailout involving a massive shift of debt from the central bank to the chartered banks, the federal government made good the hole in their finances, but downloading programs with adequate funds to pay for them onto the provinces, that passed on the compliment to the municipalities. There is thus a moral obligation of Ottawa to pass on all or part of the interest reaching it as dividends from provincial borrowing from the Bank of Canada or from municipal bonds accepted as security for loans by the Bank of Canada with the guarantee of the federal or provincial governments. Utilizing the provisions in the Act would thus open new dimensions of understanding amongst the three levels of government.
And why would the three professors not devote a word to the use our banks have made of the capital that they were re-endowed with at the expense of the taxpayer since that great act of charity to our banks carried out between 1988 and 1993? They would find the answer on the front page of the Report on Business of The Globe and Mail of 17/08, which reported the settlement by three of our five really large banks out of court of a suit by Enron, possibly the greatest financial scandal of the age. It is worth noting the $274 million settlement by the CIBC before the case came to court for devising the complex derivative plays that kept liabilities off Enron’s books, and sent a top executive of Enron and his wife to prison for ten years.
It is intriguing to note that the Canadian taxpayers are in for another costly bit of charity to CIBC, since approximately $100 million of the settlement will be chargeable against its earnings in Canada. RBC has made a smaller settlement out of court with Enron as plaintiff, while TD still is facing a court case with Enron. On top of that is the moral black eye that Canada has received by financing the banks and making it possible for them to advise a miscreant US corporation on better ways of abusing the public.
Obviously the whole mess of the takeover of our economy by our deregulated banks calls for a Royal Commission that will guarantee that all suppressed vital angles will be heard. This should be a key if not the key issue of the present election campaign.
William Krehm
– from Economic Reform, January 2006
[The points made in this article do not directly translate to the position in the UK, but are generally relevant. – BL]