7The Greatest Central Bank Goof Ever
In organizing the world-wide bank bailout of the early 1990s, BIS overlooked a crucial detail.
When you allow the banks to load up with government debt 100%-leveraged, and then proceeded to raise interest rates to the skies "to lick inflation," you court disaster. For higher interest rates bring the market value of pre-existing bonds with lower coupons tumbling. And in his annual report for 1991, Alexandre Lamfalussy, head of BIS, announced that he would no longer be satisfied with 1% or 2% "inflation" that even the best central bankers have brought in, but would insist on a clear zero. As a result interest rates shot upward and threatened to collapse the world monetary system. That convinced the US Treasury that the day of sky-high interest rates was over. "Accrual accountancy" (aka "capital budgeting") had become indispensable. Carried back to 1959 the adjusted figures of the Department of Commerce retrieved some $1.3 trillions previously written off.
The change was called "savings," which it certainly was not. For rather than the cash and near-cash securities that "savings" usually implied, the rediscovered physical investments were in the form of roads, bridges, buildings, and highways. But a wink to the bond-rating agencies sufficed to convey the real situation. It brought down interest rates, gave President Clinton a second term, and Wall Street a boom that lasted until the high-tech bust of 2000.
The Savage Accountancy Games
However, there is far more involved in all this than can be conveyed by a wink and a nudge to the bond-rating agencies. Today the very system of accountancy is a subject for some very savage games being played between corporation and corporation, as between governments and corporations. That much you can gather even from a casual reading of our daily financial press. The great late French economist François Perroux summed this up probably better than any other economist, when he spoke of the "dominant revenue." This under a given social system – both by the volume and rate of its return is held to determine the welfare of society as a whole. That may be so only from the angle of vision of a particular social group in the saddle. If power shifts to another such group its revenue comes to occupy the dominant position. In this way after the Napoleonic Wars it was the land-owning class in Britain who behind high tariff walls protecting domestic food market profited mightily at the expense of the new industrialism that had to pay higher wages for its workers to keep body and soul together. At the time no more was offered by the industrialists and the economists who expressed their interest than that wages sufficient to allow their workers to renew their working force and to breed the next generation of labourers. That, to the satisfaction of David Ricardo and his clergyman friend, the economist Thomas Malthus, constituted the "iron law of wages" – anything more would merely lead to the workers having larger families because of their inability to practice abstinence. In that position of Ricardo Karl Marx was delighted to find confirmation of his very different view of the "iron law or wages" and the labour theory of value. To him and his followers it confirmed the need and possibility of a working-class revolution.
Today there is a new social vision implicit in the difficulties that corporations and government are experiencing in getting the accountancy of our society straight. For by now it should be clear that not only producers, but even consumers need a higher education to handle computer and countless other baffling technologies. By switching to what is nothing more than double-entry accountancy into our books – accrual accountancy – we can adopt a dominant revenue. That would help the peaceful coexistence of humanity in all its races and religions and cover the cost of conserving our environment. That would require that human capital as well as physical capital can that must be depreciated over its useful life. That was learned the hard way in the Second World War.
At its end Washington sent hundreds of young economists to Germany and Japan to forecast how long it would be before these two formidable industrial powers could emerge as competitors on the world market. One of these economists writing two decades later reflected on why their predictions – including his own at the time – had been so wide of the mark. He concluded that it was because they concentrated on the physical destruction and overlooked that their highly educated, disciplined work forces had come out of the conflict essentially intact. That netted for Theodore Schultz the Bank of Sweden Prize for economics and a brief celebrity. Today he is forgotten except by a few like COMER.
The Slow Depreciation of Human Capital
The investment in human capital survives more than the generation in which it is made. For the children of educated, healthy parents tend to be healthier and better educated. Properly accounted for, that would take care of the extra services necessary for our longer average life expectancies. If human capital assets were recognized in our official accountancy, our government’s balance sheets would not only be in fair share but in surplus. This would permit catch-up not only for the neglected environmental conservation, but for generous assistance to the disease and poverty-ridden parts of the world such as Africa and parts of Asia. It would provide means and need for putting into effect the concepts of the social heritage of Major Douglas. The first step in that direction is to grasp the interdependence of Perroux’s "dominant revenue" and the accountancy accepted by governments and society. This will allow, indeed invite, the lowering of the pressure in the social steam kettle that currently is designed to crush and destroy rather than to conserve and help flourish.
What we require towards that end is: (1) a knowledge of the work of the great economists whose work has been expunged from human memory. COMER hopes shortly to announce an initiative that it is planning in this sense. (2) A knowledge of our own history and how it could interface with other cultures. Certainly the sad experience of our American neighbours in Latin America, Europe and Asia should serve as a warning, and induce us to lend them much-needed help in reorienting their, and our, foreign policy before it is once again too late. Hectoring in Latin America, Vietnam, has led our government to the quagmire of the Near East. Our roaming bankers must be brought home and confined to banking – if properly controlled, a socially highly useful art.
We must become aware of the perils of espousing a view on banking or whatever aspect of the economy, without considering what the conditions at the time have contributed to a particular formulation of the problem being considered. I have mentioned briefly the suddenness and violence with which the high hopes collapsed in October 1929. The banks of the nation had shut their doors. Figureheads not only amongst economists but amongst the great industrialists of the day, were prepared to throw in their hands. You can not shut 38% of a nation’s banks and expect the other 62% go on functioning. The opposite of banking is 100% money – i.e., nothing is lent out by banks except what has been borrowed elsewhere by the bank – for the simple reason that it has forfeited public confidence. Only government guarantees could begin saving the banking institution.
Moreover, advocating 100% money does threaten one of the greatest assets that Canada has in our struggle to make the Bank of Canada Act which is still intact on our law books, though completely ignored by the government. In it we have a detailed description of the funded and unfunded debt that the central bank may lend to the federal and to the provincial governments, and with their guarantee to our woefully under-funded municipalities. The time has come to do something about it.
– from Economic Reform, April 2007