Snagging Some Attention in Kingston
The campaign of Kingston COMER affiliates to secure funding for municipal infrastructure and other public investments through Bank of Canada caught the attention recently of Andrew Ball, a business and economics journalist with Queen’s University Student Radio, CFRC, at 101.9 FM. His comments on the proposal were heard by some COMER members who are among his regular listeners, and they alerted Richard Priestman, president of the local chapter. Richard initiated a correspondence with Mr. Ball, which led to an invitation to attend the next regular meeting of the group. Mr. Ball accepted, and brought his micro-recorder to 99 York Street on October 19. (His condensation of the discussion was broadcast on Wednesday, the 22nd.)
A Little Nervous Throat-clearing
The discussion was tentative and exploratory, for the group had not adopted a collectively prepared set of talking points in support of cryptic policy statements that Richard has managed to get into local press and public forums. (See past issues of ER for examples.) It therefore became an opportunity for a review of essential COMER precepts and policy prescriptions as perceived by the individuals in attendance. Initial expressions of concern that contradictory viewpoints might emerge under this format soon evaporated as individual contributions proved to be mutually reinforcing, with minimal digressions, and focused on the issue that had aroused Mr. Ball’s interest. In this atmosphere, Andrew was a participant and responded to questions about the content of training programs for business students and of economics policy courses that he personally follows as an elective. An economics text currently favored in university programs was on the table, and reference was made to it in parts of the discussion.
It will be no surprise to readers of ER that discussion focused on the virtually universal reaction of business and economic policy commentators to the proposal that Bank of Canada be used more aggressively to finance public investment in obviously needed areas such as municipal infrastructure, health promotion and medical care, education, development of alternative energy sources and reduction of CO2 emissions. That is, it would be inflationary.
There was all-around agreement that inflation is a difficult concept to pin down, and especially to calculate accurately. It was noted that business news from radio and TV regularly presents it as simply an increase in some price index or other. Furthermore, the explanation offered frequently alludes to some factor such as crop failures in Florida or oil pipeline explosions in a war zone. These factors constitute a real increase in cost of production. Higher prices are not necessarily inflated prices, in other words, for they can reflect higher costs. The traditional, indeed the essential, meaning of inflated prices is that they are blown up by the non-real villain of monetary instruments that can’t hold their value. This failure is normally attributed to excessive growth in the quantity of money. To quote the economics text: "When a government creates large quantities of the nation’s money, the value of the money falls." More generally, any excessive increase in M(oney supply) can cause an increase in P(rice level) unless the Q(uantity – including quality) of goods produced grows also. This happened famously to Spain with the gold it brought back from the New World. And even more famously to Germany in the 1920s.
Attention then turned to the role that legislated powers of the Bank of Canada should be playing in the financing of municipal and other public-interest investments. Mr. Ball had expressed concern that this would inevitably entail an increase in money supply. He had circumspectly stopped short (in a letter to Mr. Priestman) of saying that this would be inflationary, however. And indeed it need not be. Many volumes of argument and historical experience can be cited to demonstrate that an increase in money supply may facilitate a commensurate or even greater increase in real production. Putting it the other way round, an inadequate supply of money and/or credit can be a serious constraint to production and exchange. A critical consideration is the time horizon that is built into a deliberate increase in money supply. Investments in education, transportation networks, water and sanitation conveyances, scientific research and technology development, health maintenance, resources sustainability, etc., make a society more productive and prosperous, but it may take some time to reap the full reward. The kind of increase in M that is required for these purposes is more accurately conceived of as credit. The German hyperinflation was the consequence of printing ever greater quantities of currency in an effort to command a quantity of goods that was not increasing. The government in that case was competing as a consumer. The COMER proposal, by contrast, is for government to expand the supply of credit to invest for longer term, more permanent prosperity.
The Advantage of Owning a Bank
When government invests for purposes such as those mentioned above, it must do so on credit, for current tax revenues are sufficient for little more than regular operational requirements. The costs of borrowing (interest payments) become an operating expense and are added to the government’s annual operating budget. That is how Canada was developed, from the days of John A. Macdonald and the financing of the Pacific Railway, for example. And from the late 1930s until the 1970s, the Bank of Canada was used to finance wars and megaprojects without inflation or runaway debt. An important reason for that benign effect is that the Bank is wholly owned by the Government of Canada. That means that annual interest payments on government borrowings for investment in development projects, which are revenue to the Bank, are mostly returned as profits to the sole shareholder. In other words, investments in important public infrastructure can be, and have been, virtually interest free. Hence, the question that affiliates of COMER are putting to their political representatives around the country is "why aren’t we using the same means now, when our needs are obviously pressing?" ("If we own the bank, why aren’t we using it?")
The answer that "it would be inflationary" is highly suspect. If true, why was it not the case prior to the 1970s? What has changed? To predict inflation implies that the proposed investments would not be productive (of an increase to Q in the equation MV=PQ). And it suggests that the real issue is how aggregate national resources should be allocated. That is, for what purposes (and in what relative quantities) should our men and materials be used, in the concrete, material sense. Even more critical are the issues of who should get to make those decisions and reap the benefits.
Allocation before Distribution
As already noted, well-designed and executed investments in public utilities make individuals and enterprises more productive in the future. (Private developers in the Alberta oil sands understand that they will not succeed for the longer term unless Fort McMurray becomes more comfortable for the rapid influx of workers.) If men, machines and materials are already being used to full capacity, then a rational allocation calls for a rank ordering of projects and selection of the most important ones first. Because there is no benign dictator at the top to make these decisions, there is competition for resources among proponents of the various projects and a bidding war for men and materials may ensue. Projects with the promise of most immediate and highest returns are those most likely to win. In the short term, therefore, competition for resources might cause some activities to be postponed in anticipation of lower relative prices after the current burst of investment projects starts bearing fruit. These conditions might look like inflation, but they are also the circumstances of real growth in the nation’s productive capacity. They therefore offer the opportunity for a general increase in welfare.
Closer examination of the inflation bogey suggests that it is a convenient smokescreen used by a few powerful members of society against the interests of the great majority. In other words, the issue is distributive justice as well as resource allocation. Even under conditions of full employment, a truly sovereign government could out-bid private investors if public investments were of highest priority. At this point detractors appeal to the massive government debt and its burdensome carrying cost to taxpayers. The response of COMER, of course, is that this debt was unnecessary and can be eliminated through effective use of the Bank of Canada. As Mr. Ball noted, the debt is conventionally attributed to "the high spending days of Trudeau, Mulroney, and a couple of wild minority governments." The origins of the debt and the beneficiaries of the interest on it that is paid by taxpayers expose the distributive issue. The question of origins, as well as why Bank of Canada financing of development projects was not inflationary in the past, and of what happened to change the situation, requires a search into the past. As a few of the pertinent details were put forward and discussed, Mr. Ball noted that his course work in economics and finance has emphasized mechanical expertise and abstract principles in contrast to an historical approach. (This is probably a general situation in university programs and merits investigation by COMER members.)
History, for Empiricism over Assumptions
Time did not permit a detailed exposition of the changes to banking (non) regulation over the past three decades that led to the present situation (as chronicled in ER and other documents and books), but some important consequences were noted. Partly as a response to pressure by the banks in the face of major losses on their investment ventures in the seventies and eighties, the federal government gradually transferred most of its borrowing to the private market. When BoC sells government bonds, it depresses their price, raising interest rates. Government guaranteed returns were a plum that capital pools could not resist, even though it meant competition for private investment projects. The consequence was a sharp spike in interest rates, a "favor the saver" policy that produced a budget deficit as government interest costs shot up, forcing even more borrowing and a consequent ballooning of government debt. That was the "spending program" that got the government into trouble. It transferred billions of taxpayer dollars to private investors via record-high interest rates. That is how the debt was created and how paying the interest on it continues to dwarf all other federal budget items today. In this situation, tax revenues reward private investors. That might be acceptable if there were some distributive equity in ownership of the debt. And there would be if more of it were owned by Bank of Canada.
It was acknowledged that there is a fairly widespread opinion that governments ought not build and operate enterprises, period. (Many COMER members might agree with this when it leads to giving away going concerns to friends of the government!) Proponents of this view have some serious arguments on their side. It is supported by critical analyses of bureaucratic organizations that are operated (ineffectively or perversely) by governments and funded by tax revenues. On the other hand, there are some social functions that seem ineluctably public in nature, and there are ample grounds for believing that they are under-funded at this time. This is a political issue, however, and to dismiss the COMER proposal for use of the Bank of Canada as inflationary disguises the political preference by suggesting that opposition is based on "economic science."
In connection with the possibility that government-funded projects might overheat the economy, it was pointed out that legislated powers of the Bank of Canada give it the option of restraining credit expansion by private banks. It can impose or change reserve requirements. Banks were once limited to lending no more than ten times the amount of deposits they held. Removal of this limitation was one of the changes that has occurred since the early ’70s. This topic led to two interesting observations:
• The economics textbook says that the reserve requirement was suspended in order to "give banks a level playing field." They complained that they were not being treated fairly by having to maintain reserves with Bank of Canada when other credit-granting institutions were not so constrained.
• Mr. Ball manifested some surprise at this, because he was under the impression that the reserve requirement is still in place.
The foregoing is particularly significant because the textbook on the table was one that Mr. Ball recognized as the one he had studied from in Economics 101. Since Andrew also told us that he has taken subsequent courses in economics and finance, it strongly suggests that intermediate and senior level courses fall back on traditional concepts of money mechanics. As he also told us, the courses he has taken focus on abstract principles and pay little attention to history.
(George Biro, Don Findlay, Richard Priestman and Peter Zuuring made written contributions to the preparation of this report.)
– from Economic Reform, November 2007