By Adam Smith, 21st Century
NB – this paper is a work in progress and will be updated with better graphs with their sources listed
This paper is dedicated to John Monroe and Michael Karp, without whose exposing of my ignorance on the monetary system I would not have found impetus to delve as deeply as I have.
Ah the Bank and Canada and 1974! I don’t think there’s a central bank in the world with more wild mythology surrounding a precise point in time. I must admit however, were it not for this mythology I would not have found myself motivated to dig as deeply as I have to find the truth. In revealing this truth to others I have been called a government apologist and/or shill, a secret insider of “controlled opposition”, and many other names by ideologues whose conspiracy theorist identity is so wrapped up in the myth that their cognitive dissonance and confirmation bias won’t allow them to accept new facts that belie their prior misinformation. The irony being these people spent so much time researching bunk sites for false info but refuse to look elsewhere because the truth doesn’t fit their narrative.
I’m not doing this to justify or defend our monetary system, it is in serious need of reform as it is simply another gear in the inequality engine/wealth vacuum for the elite we call an “economy”, but the truth needs to be told, we cannot fight for change based on false history and misunderstood systems.
Before moving any further, in case some people reading this are uninitiated, there are some realities of the banking system I need to put out there if you are to understand why lately there’s so much talk of monetary reform, and MMT, and public banking, and why it’s perhaps the most important issue facing the entire global economy.
The basics of the monetary system:
If you’ve never read anything about the monetary system in Canada the best place to start is right here.
It’s a short read, but the gist of it is, the vast majority of the money supply in Canada is created when private banks make loans. Yes, whether a credit card, business loan, line of credit, or mortgage, when that bank gives you that money it is not the savings of other depositors, it is not the bank’s money, it is not some percentage of some commodity like gold or a percentage of central bank reserves, it is simply numbers typed into a computer and PRESTO, new digital money you can spend.
The power to create money at will puts private banks at the center of the economy. If money is the lifeblood of the economy, banks are the heart pumping it through. History is replete with instances of this immense power being abused by fraudsters, and Canada is no exception. Even in the current era of relative stability and lack of fraud, the power wielded by our banks gives them both economic and political clout and the ability to ensure the economy remains a wealth vacuum for the elite.
I don’t want to delve into the intricacies of the monetary system, while this paper gets into some technical details, mostly it is debunking the history of what actually happened, so you can enjoy the paper without being intimately knowledgeable of the monetary system. But there is some basic terminology I should probably give context.
Other than physical cash and coin, most money exists digitally, just numbers in a computer, deposited in a bank somewhere. So, when speaking of money in a bank we refer to it as “deposits”. Anytime this paper mentions deposits or the creation of deposits, “deposit” is synonymous with “money”.
But the complexities of defining money don’t stop there. There is also another type of money, money only used by the central bank and financial institutions to settle their transactions at the end of the day. This type of central bank money is called “reserves”. Reserves are also money, but only used by the central bank and financial institutions.
If you find this supremely confusing you are not alone, it’s designed complex on purpose so that regular people don’t attempt to understand it and don’t realize the simple truth of banks creating money. As economist John Kenneth Galbraith said in his treatise on money:
“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.”From “Money: Whence it Came, Where it Went”, 1975
Truer words were never spoken…
The other important concept to understand is the balance sheet. The balance sheet is always divided into two parts: assets and liabilities. Assets are what you own, liabilities are what you owe. Your house would be an asset, your mortgage is a liability. ALL of the financial world is divided thus, and being part of that world means we are too; as agents in the economic system we are each a walking balance sheet of assets and liabilities. Here’s the only tricky part to keep in mind: in terms of your finances, your assets are your banks’ liabilities and vice versa. Here’s a diagram to illustrate the point:
Because your deposit is something the bank owes to you, it is your asset and it is the bank’s liability. Likewise, as you owe your mortgage to the bank, it is the bank’s asset and your liability. The important thing to remember is the definition (assets = own, liabilities = owe), so you don’t want your liabilities to outweigh your assets, otherwise you are in the red and not financially healthy.
Lastly, one should understand what is meant by “inflation”, however most of the public are already familiar with this concept. It is the (usually) gradual devaluing of money. A dollar in 2019 does not have the purchasing power of a dollar in 1935, that is inflation. And it is the primary concern of central banks around the world.
For some brief personal context, let me tell you how I came to be obsessed with the BoC and 1974. I got interested in monetary reform simply by learning about the system we live in and the nature of banks and money creation. It started with watching the first Zeitgeist movie (I’ve come SO far since then, as Zeitgeist is chock full of myths and inaccuracies too) and getting an interest in banking. Eventually that led me to the group the Committee on Monetary and Economic Reform, where I connected with the board.
But COMER’s founder Bill Krehm was quite old (he recently passed at 105); we no longer had his expertise to explain the intricacies of the monetary system, and a couple of the myths were being innocently propagated by COMER itself. I too had read the myths, on various sites and from various sources, and had eaten them up whole. But when sharing that information on various social media forums I kept getting called out, primarily by John Monroe, that my information was incorrect.
When John kept calling out the myth I would go into research mode and do my damnedest to prove him wrong and the myth right. But then a pattern emerged: the myth seemed to only exist on third party sites, many clearly of the conspiracy theory sort, I could not find any evidence of the claims on any official site. Now, that’s not to say it didn’t happen, 1974 was a long time ago and the government has only digitized so much from back then. More importantly, the BoC website did not go back nearly far enough in its monthly review or annual reports.
So began my years long quest for the truth about the BoC and 1974. I’ve bought nearly every book on the Bank of Canada in existence, some quite aged and dusty tomes, I’ve read the books of Bill Krehm, I’ve read many technical papers on the BoC website, but in the end the only way to dig right into that era was to go to the Toronto Reference Library and unearth the old Bank of Canada Reviews and Annual Reports from the 70s into the early 80s. And boy does it tell a tale. I’m going to pick the myth apart piece by piece in sections.
Let’s start with the myth itself, it varies from place to place but the overall gist goes something like this:
“In 1974, at the behest of the Bank for International Settlements, the Rothschilds, and foreign banking interests, without debate in Parliament Pierre Trudeau ordered the Bank of Canada (in some incarnations the myth claims the BoC was sold to the former interests) to stop lending interest-free to the government for public works and to start borrowing at compound interest exclusively from private banks, and because of that you can clearly see our public debt skyrocket on a chart. This history has been covered up by the government, as they also ordered the media not to cover the Bank of Canada lawsuit by COMER.”
Well, if you believe any part of that, regardless of which parts you combine, you will be disappointed to learn that it is 100% false. There is not a shred of truth to ANY part of that statement. There are some things that could be considered distortions or confused history, but make no mistake, it’s all false. And I’m going to prove it once and for all to put all the misinformation to rest.
The BIS, Rothschilds, and foreign bankers:
The first part of the contention is that we made some change at the behest of one or all of the following: the Bank for International Settlements (BIS), the Rothschilds, and/or foreign banks. In some variations we even sold the BoC to private banks and/or the Rothschilds. All incorrect, but some history seems to be confused.
In terms of being sold to the Rothschilds or other banks, wrong, the BoC has been 100% publicly owned since it was nationalized in 1938. In terms of being controlled by them, we’ll get to that in a moment.
Where the history may be getting confused is we did do something sort of significant with the BIS in 1974: we participated in the first Basel Committee resulting in the Concordat. But that had nothing to do with monetary policy, it was all about how to maintain the security and supervision of banks’ foreign establishments and ensure they are all operating under comparable standards. This is important because banking being what it is, a private for-profit business with the ability to create money, historically it naturally attracts scammers and psychopaths yearning for money and power. If anything, the last couple decades Canada has become a leader in this arena, being a shining example of a strong resilient financial system that weathered the storm of the ’08 crisis better than most and imparting our wisdom to other nations.
Now, that’s not to say we aren’t following the same neoliberal policy prescriptions of the likes of the BIS, Rothschilds, and foreign banks, but it’s not because we are controlled by them, it’s because all the banksters are on the same team and have the same neoliberal indoctrination through their education. People don’t get into banking and finance with a view to reforming it, they get into it either because they love numbers and/or because they want to profit from it, and so they learn how the system works and conform to that. The reforms that have happened are always in favour of the banks, and they have pretty much written their own regulatory and legislative changes over the decades.
The indoctrination of the disciples of finance goes deeper than merely their education teaching them about the system as if it is some immutable process, based on mathematically and scientifically-determined best practices, guided by proven standards and regulated for the benefit of all, rather than the inequality engine and wealth vacuum for the psychopathic corporate elite it actually is. Economics and monetary theory are not based on universal rules handed down by the gods nor did they emerge from the physical laws of nature. They are an invention of man, no different than a game of Dungeons & Dragons, and the supposed rules and structures of that system are based on psychopathic assumptions about human nature to create specious technical justifications to maintain the supremacy and speculation of banks and the financial system within a supranational corporate oligarchy.
The financial acolytes and the general public are also indoctrinated to believe that the various gains of the modern world are somehow directly attributable to the neoliberal capitalist system, as if none of it were possible otherwise. As if the economic results were a calculated decision by the ideologically programmed machinery of the system itself, and not the sum decisions of actual living people. Completely untrue of course, and many finance workers actually believe they are contributing positively to society at large, unaware they are merely a cog in the wealth vacuum for the elite, but this is not the paper to get into that.
The BIS does advocate for the independence of central banks, as you can see in this statement:
“monetary policy autonomy may be at risk if the central bank can be obliged to lend to the government or provide it with implicit or explicit subsidies in other ways, for example by supporting the price of government debt.”
But that is a common and longstanding sentiment of bankers and central bankers, not some new notion applied only with the advent of neoliberalism in the 70s. You can go back in the literature of Canadian central banking and see many expressions of that concern from the very get-go in 1935, because it is a valid concern. Technocrats are wary of the machinations of politicians more concerned with being re-elected than of the impacts of short-term beneficial economic policies that may lead to long-term imbalances.
There are other historical examples of developing countries abusing their money creation powers and causing economic turmoil (although sometimes it’s less the result of the internal effects and more from external powers punishing the nation, as we see in Venezuela right now). But the irony there is that currently, developing nations are not allowed to use the same kind of expansionary policies that built up a strong public sector in developed nations in the post-war period. Now they must rely on foreign loans burdened with neoliberal conditions of austerity, privatization, and corporate control.
There is the valid observation of the secrecy of the BIS however. Yes, their meetings are secret, central bankers only, but while the meetings are secret any policy originating from those meetings would still be fully public if a central bank tried to implement them. The BIS is also very strictly NO POLITICIANS allowed, so any notion that an elected official, especially one ranked as high as prime minister, would be allowed to set foot in the building is simply unthinkable. Nowhere in any history will you find any suggestion that the BoC changed something in 1974 at the behest of the BIS, as you will discover later, none of the changes that actually happened originated with them.
Without debate in Parliament Pierre Trudeau ordered the Bank of Canada:
Pierre Trudeau did no such thing. First of all, while the governor of the BoC and the finance minister regularly meet to discuss monetary matters, the finance minister does not give the governor their marching orders. They consult with one another, but the governor and the BoC are free to do as they feel necessary (the glorious independence of central banks). The governor also occasionally speaks in front of parliament to update them as well. If you go back in Hansard (the record of parliamentary debates) you’ll see some pretty embarrassing questions of the governor by MPs who clearly don’t understand the monetary system. If a conflict arises the finance minister can issue a directive to compel the governor (a clause installed in the BoC Act after the Coyne Affair), but that power has never been used.
More importantly though, the PM would not themselves be issuing any orders, it would be the finance minister. And no such directive was ever issued. If the PM were to ever start issuing orders to the BoC its autonomy would be threatened and Canada’s global economic neoliberal reputation would be in peril, likely devaluing the dollar and causing divestment from the country.
Due to the years of disagreement between the Diefenbaker government and Governor Coyne in the 50s leading to the Coyne Affair in 61, and low growth and inflationary concerns in the late 60s and early 70s culminating in the OPEC oil crisis in 1973, monetary policy was under a spotlight and was hotly debated in the House of Commons and Senate, it was no secret. They were all talking about it, especially grilling the governor in the House to ask, over and over, whether or not the BoC was pursuing a “tight money policy”.
The BoC also does absolutely nothing in secret, anyone claiming so has a gross misunderstanding of how central banks operate. They try to be as transparent and predictable as possible in order to foster stability and smooth sailing for the financial system, in particular money markets. Markets do not like surprise announcements and certainly don’t like overarching changes without any consultation. Rest assured the changes the BoC did make (albeit in 1975) were not remotely secret and were done with the full knowledge and collaboration with government.
To stop lending interest-free to the government for public works and start borrowing at compound interest exclusively from private banks:
This one has a few variations to unpack, but first lets get one big misconception cleared up. The government has ALWAYS sold bonds to the BoC and ALWAYS sold bonds to private banks, all that changed was the ratio, and that didn’t happen until 1982 (more on that later). It is important to say “sold bonds” rather than “borrowed the money” because bond purchases by banks don’t actually technically fund government spending, like at all, that’s one of the neoliberal lies we’ve been told. The government deposits created at private banks when those banks buy government bonds are just holding accounts, the government does not spend from them (for the wonks, here’s a great post from MMT godfather Bill Mitchell on the topic).
But there’s a more important distinction that needs to be made here, the difference between “loans” and “monetary financing”. A lot of people point to the BoC Act and claim the loan provisions prove that the BoC used to make loans and no longer does so. That’s a huge misinterpretation of the function of central banks and the purpose of the loan provisions in the Act.
The BoC has actually made very few loans to governments in its lifetime, I’ve gone back into the Canada Gazette to unearth EVERY instance of a loan to either a province or the feds.
As you can see, it’s a short list. This is because these loans aren’t meant as loans to cover deficits, fund services, or build infrastructure; they are loans to cover temporary unexpected budgetary shortfalls, which is why the loan provisions in the Act are so limited in amount and time frame for repayment. You could never use a loan due in one year to build a critical piece of infrastructure. As you will also note from the balance sheets, the loans did not exist for long, they were repaid quickly.
It’s also false to claim the BoC made loans for infrastructure because it doesn’t extend loans to the government for a specific purpose, the money goes into the pot of the Receiver General’s account and it’s up to the government to spend it through fiscal policy. The BoC is not an infrastructure bank or development bank, it is a central bank, it is concerned with monetary policy, the money it creates for the government is not earmarked for some specific fiscal policy.
More to the point, a central bank is not a bank intended to regularly make loans, it is a “lender of last resort”, meaning only if funds cannot be procured in any other way does the central bank make a loan, whether to a bank, financial institution, or government. This is all part and parcel of the notion of central bank independence discussed earlier, the BoC is simply not intended to be a piggy bank for the government. While there are good reasons for this, they don’t really apply to a responsible government not in crisis in a developed country with a healthy amount of trade whose only reason for increasing monetary financing is to mitigate the (false) neoliberal perception of the burden of public debt charges on budgets.
So, what was the BoC doing more of in the past that helped fund our public works? Un-neutralized monetary financing! Monetary financing is when the central bank buys bonds from the government which then credits the government with new reserves (central bank settlement money) in its central bank account. This form of public money creation is described in the government page from the start of this paper. The “un-neutralized” aspect is key, because there is no cost-free way to fund deficits as long as the BoC fully neutralizes its operations (more on this later). It can be considered a de facto “loan” because technically selling bonds is “borrowing”, but it is not subject to the loan limits of the BoC Act. It’s kind of a back door loan if you will, and never really needs to be repaid, the government could roll over the debt time and again with a new bond issue that matches the maturation of the previous issues.
This is also where the “interest-free” myth comes from. Monetary financing means the BoC “buys” government bonds, but the government must still pay interest on those bonds to the BoC, which then after costs gets returned to the government as the profits of the BoC (confusing I know, this is the strange dynamic when the government owns the bank that runs its business). This is why it is NEAR interest-free, but never entirely interest-free.
Monetary financing is like making a loan to yourself, such is the power of a federal government with a publicly owned central bank and a sovereign currency, they can turn on the taps to create more money any time they please. The reason they don’t is multifaceted; firstly there are valid concerns about inflation if you heat up the economy too much, there’s also the effect on trade from reactions of foreign economies if they feel a nation is unfairly subsidizing its people, but mostly it’s because more public spending does not further the interests of the wealthy elite. It must also be understood, whether selling bonds to the BoC or to private banks, the government does not put out different priced bonds depending who’s lending to them (in fact, that’s the whole neoliberal logic behind it, to ensure the central bank is paying market rates).
We currently do about 14% monetary financing, that is the percent of our total debt that the BoC holds, the rest is owed to investors of all stripes (we’re currently about 1/3 foreign owned). As mentioned previously, one of the prescriptions of the BIS is not to be funding government deficit spending through the central bank. However, this is one of the exceptional aspects of the BoC (other central banks, like in the Eurozone, are strictly forbidden from buying the bonds of their governments), we have always regularly had the BoC purchasing our bonds, it’s just part of its functions.
The monetary financing we do is less about funding the government than it is about maintaining monetary policy, keeping a stock of bonds on hand to grease the wheels of money markets, and as an asset to balance the liabilities of physical cash and the Receiver General account. But that monetary financing used to be higher pre-1982, peaking just over 25% some years, and that is the time Canada was building a lot of public works.
That is also the time we were using “un-neutralized” expansions in the money supply to accomplish the economic growth of the post-war period. That is what the Levy paper “Is Monetary Financing Inflationary?” was all about. Because of the absurdly complicated way our monetary system is structured, when the central bank (on behalf of the government) spends money into the economy it creates new bank deposits, hence the money creation aspect. These new deposits become new liabilities of the private banks, so to balance out those new liabilities, the central bank simultaneously transfers a bunch of reserves to balance the assets of the banks with these new liabilities.
But banks do not like holding reserves, firstly, because reserves are central bank settlement money there’s little they can do with them other than lend their excess to other banks, and secondly, they earn the bare minimum of interest. This is also part of the reasoning the banks gave when lobbying successfully for the BoC to eliminate reserve requirements. So to accommodate the profit-hungry banks the BoC will “neutralize” (some central banks call it “sterilize”) the government spending by using open market operations to swap those excess reserves for highly liquid risk-free government bonds, which are mostly used as general collateral in money markets to back loans, or can be traded for various other assets the banks choose to line their investment portfolios with.
Before we started paying interest on reserves, when the BoC used to expand the supply of reserves without neutralizing was when we were in an era of cost-free public money creation (excepting the operational expense of running the BoC). Without swapping reserves for bonds the government could spend new money into the economy without paying interest to bond holders. But when we switched to a 0% reserve system in 1991 we started paying interest on the reserves banks held, the Deposit Rate, so now, it doesn’t matter whether or not we neutralize spending, whether it’s the interest on reserves or the interest on bonds, we pay interest to banks on every dime the government spends into the economy.
However un-neutralized monetary financing wasn’t the only trick in our central bank’s bag. The Ryan-Collins paper gets into the various other ways we used unconventional monetary policy to fund public works, including methods like encouraging banks to give loans to customers with which they would buy Victory Bonds to fund the war effort. A super roundabout way of doing it (this is why the Victory Bond issue ballooned so big it required the Conversion Loan of 1958), but none the less ensured war funding while preventing inflation by capturing savings. The important thing to note is that there WAS more progressive use of the BoC, and it was more concerned with full employment, but to claim it was some kind of lending institution for public works is simply false, it’s a misunderstanding of how central banks work. Other than WWII, at no point would the government come to the BoC asking to loosen monetary policy for some specific project like infrastructure, it was overall just a different time with different attitudes and a very different economic environment of unprecedented growth.
The other problematic claim in this is the compound interest. While Canada has released bonds with compound interest (Real Return bonds) they are few and far between, the vast majority of our public debt is bonds and treasury bills (t-bills) and neither have compound interest. A bond has a “coupon”, a set amount of simple interest that it pays out, either over time or at maturity. A t-Bill is sold at a discount, and at maturity the full value is paid back, the difference being the interest. An investor might speak of these things as compounding if in their portfolio they use incoming dividends to automatically purchase new bonds, expanding their stock and the interest paid on them exponentially, but that’s not the same as the bonds or t-bills actually paying compounding interest.
As for selling bonds to private banks and investors, we’ve ALWAYS done that, I don’t know there was ever a time in modern history where the government of Canada wasn’t selling bonds and paying interest on them. And we never completely stopped selling bonds to ourselves and only sold to banks. To reiterate, we’ve always sold bonds to the BoC and always sold bonds to banks, what changed was the monetary financing ratio, how much we sold to the former compared to the latter.
So, the notion that in the past we used interest-free loans from the BoC to build infrastructure is incorrect on a few levels. What we did do in the past was higher levels of un-neutralized monetary financing during a time of building alot of public infrastructure, but that was going on all over the world in the post-war boom. It was a progressive time of blossoming Keynesianism and explosive (and ultimately unsustainable) growth.
Because of that you can clearly see our public debt skyrocket on a chart:
The most annoying part about this claim is that it’s like people look at the chart of Canada’s public debt (unadjusted for inflation I might add), see the rise after 1974, and rather than find out what was happening in history at that time they just assume it is entirely attributed to some change in policy of the government and/or the BoC. It’s like other than looking at a two-dimensional chart they feel absolutely no deeper historical context is required to understand how such an astronomical rise in debt occurred.
The casino of financial market speculation reached an all time high at the end of the 20s, resulting in a stupendous crash in 1929. The following Great Depression kicked everyone’s asses, and that’s when in 1935 the newly minted BoC first got its chance to shine. It created tens of millions of dollars out of thin air both for the government and to capitalize the Industrial Development Bank (now the BDC) to make loans to small and medium-sized businesses, pulling us out of the Depression and ending the work camps. We nationalized the BoC in 1938, then we used our money creation powers again to help fund WWII, from which came the famous question and answer from the first BoC Governor Graham Towers’ testimony before the Committee on Banking and Commerce:
“Q. Would you admit that anything physically possible and desirable, can be made financially possible?
Mr. Towers: Certainly.”
After the horrors of WWII it was peace and time to repopulate. Enter the baby boomers and the unprecedented economic growth of the post-war period. Canadians were popping out babies by the literal dozen, and the need for employment and new housing and infrastructure for these expanding populations was driving growth in every way. Populations were growing, profits were growing, wages were growing, unions and organized labour were growing, and things were still very affordable. As the early boomers aged new hospitals and high schools were built, and then new universities. But with all that growth, inflation grew as well.
Monetary systems and monetary policy are very much a constantly evolving experiment, ours was still in its early teens in the post-war period, and a money market was almost non-existent. Through the 50s the BoC actively pursued developing a domestic money market, dealt with the Conversion Loan of 1958 when massive issues of Victory Bonds were coming due, in addition to finding its place in a non-Depression non-WWII economy of unprecedented, and therefore unpredictable growth.
As globalization was a relatively new phenomenon, and nations were still finding their footing in this new peacetime economy of massive growth, throughout the 50s and 60s there were a lot of swings of short recessions and booms. Unlike the last 40 years where most recessions and booms are entirely driven by speculation in the global casino of financial markets, in those days the real economy drove such things through actual fluctuations in supply and demand for physical materials.
The rapid growth started to hit the limits of the productive capacity of the economy, and inflation started to become a creeping concern. Interestingly, this was also a more progressive time, when equality, both of income and quality of life, was much higher, union participation was greater, and the top marginal income tax rate was over 90%. Once upon a time taxes were another tool to fight inflation, a use for them that has fallen by the wayside. Alas, the corporations love their profits and every government loves to brag about growth and employment, so they kept the economy running full steam ahead.
Hit the early 60s and Canadians are seeing inflation creep up and interest rates get higher than ever in history and they’re not comfortable (people were outraged when rates first topped 4%, if they only knew what was to come decades later). The Coyne Affair was super public and monetary policy is center stage, eventually leading to the Porter Commission and the clause in the BoC Act allowing the finance minister to issue a directive to the governor should a disagreement arise.
In 1962, due to the ineptitude of the Diefenbaker government and their public spat with Coyne (you don’t mess with a central banker without consequences from financial markets), the dollar was spiraling downward, and we had to go begging to the IMF, Fed, and BoE for $1 billion in funds to stabilize the dollar. Governor Crow theorized that perhaps under Governor Rasminsky’s leadership the BoC would have done more about inflation in the late 60s and early 70s were it not so chastened from the highly public Coyne Affair. But of course Crow’s obsessive quest to combat inflation involved cranking interest rates to historical punishing highs no matter how much deeper it drove our recession.
As inflation started to become a noticeable phenomenon, wage contracts, especially from public sector unions, started to be tied to inflation. In fact, the late 60s and early 70s were chock full of strikes and labour turmoil, as the labour force truly flexed its muscles more than any other time in history to get a greater share of the spoils of their labour. This was all well and good while inflation was in the low singles, but then BAM: OPEC oil crisis.
This is the part that really baffles me when people talk about 1974. An exponential jump in debt starts to ramp up after that and no one bothers to mention that in 1973 a decades-long global inflationary event kicked off, changing the course of economies the world ’round? What’s worse, one day I suddenly asked myself, “what was happening to the public debt of other Western nations after 1974?” and when I looked it up, lo and behold, nearly identical rises in debt in all of them, it’s not unique to Canada. This means the phenomenon was inherent to the central banking system reacting to exogenous inflation, it’s just a symptom of the way it’s structured and constrained and how that structure reacted to the inflation of the oil crisis (debt-fueled deficit spending), it wasn’t some specific change in policy they all did in concert.
So OPEC takes revenge against US foreign policy by punishing the entire world and choking off oil supply, sending the price of oil into the stratosphere. While Canada is a bit more buffered from our own oil supply to weather the storm a little better, being as dependent on imports as we are, there is no escaping the resulting inflation.
This all coincided with an environment of stagnant growth and persistent high unemployment, resulting in the combination of inflation and stagnation known as “stagflation”. The oil crisis was an exogenous external inflationary event that was the catalyst for our own endogenous homegrown inflationary wage-price spiral triggered when the inflation clauses in those domestic labour wage contracts kicked in. Stagnant growth reduced federal revenues, which required deficit spending to prevent recession, but inflation ensured deficits rose exponentially, and the wage contracts tied to inflation ensured many unionized workers in the public sector were getting raises with the inflation, so the deficit grew even faster. And there begins a two decade journey to “lick inflation”.
This history has been covered up by the government, as they also ordered the media not to cover the Bank of Canada lawsuit by COMER:
As I hope I’ve thoroughly proven, there is no cover up, the history just wasn’t readily available. And why would it be? It’s exceptionally boring to just about everyone who isn’t a monetary reformer. Even people in banking and finance care not, they are interested in how the system works currently, they are not interested in going back to past practices we have evolved beyond. The government is only going to digitize so much of our old documents, digging into the BoC Review or Annual Reports is simply not of wide public interest.
Now, as for a media cover-up of the lawsuit, well, Rocco Galati, lawyer for the lawsuit, seems to have concocted that fiction all on his own. After one of the court appearances he claimed in a video that he has it on good authority that the government has ordered the media not to report on it. While this was during the Harper years and one could be forgiven for believing he would attempt to shroud the issue in secrecy, no such thing happened.
At some point mid-lawsuit I was at a Why Should I Care? event in North York, the theme was about democracy and the media. An editor for the Toronto Star was there and I asked her about Rocco’s claim. Well she said she’s never heard of anything so preposterous, the media do not take orders from the government on what to report (with the possible exception of the CBC). I asked her if she’d heard of the lawsuit, she had not a clue.
Not too long after that, within a year or so, two of our mainstream media sources covered the story. The Toronto Star did a piece, and the CBC took it one step further with an interview with Rocco on the The Exchange with Amanda Lang.
One might argue Rocco was right, and then the media wised up and finally reported it. Or, one could realize the more likely truth other than unfounded conspiracy theory: that the Bank of Canada lawsuit interests a ridiculously small minority of people and is simply not newsworthy in the minds of the public and media. And it simply isn’t newsworthy, outside of monetary reform circles I know of NO ONE that saw either article. One could even argue the fact the lawsuit was tossed out because use of the BoC is a political decision, not a legally prescribed process, proves it was a non-event unworthy of the news. Even my parents, avid and thorough daily readers of the Toronto Star had not a clue about the article or the case. The topic is simply too esoteric and uninteresting for all but monetary reformers. Try talking about the monetary system to anyone who’s not in finance or a monetary reformer and watch their eyes glaze over in the first 30 seconds you’ve opened your mouth.
A final word on the lawsuit. While the lawsuit brought the issue of monetary reform to the forefront, getting a little mainstream media attention, uniting activists and progressive reformers across the globe (yes, we created a stir in monetary reform circles in other nations), it was always doomed to fail. When one looks at the disputed language in the BoC Act about loans, one might even call the lawsuit frivolous. An experienced lawyer should have known full well that the Act stating the BoC “may make loans” does not mean that it must or even should, just that it can. Legislation is always full of such flexible language on purpose so it is open to interpretation and application. It’s not clear what exactly Rocco hoped to accomplish other than drawing attention to the issue, because the language of the law made it clear any action is at the discretion of the authorities and cannot be imposed from the outside.
So what DID happen in 1974?
Well, other than the Basel Committee and trying to adjust to the inflationary storm post-oil crisis, not much. It’s 1975 where a change in policy happens: the BoC adopts monetarism and the Trudeau government adopts wage and price controls. In what is now known (in the esoteric annals of monetary history in Canada) as the Saskatoon Manifesto, in Oct 1975 Governor Bouey made the very public announcement of the switch to our version of monetarism called “monetary gradualism”, a suspiciously innocuous a name if ever there was one.
Monetarism is the theory that inflation is very closely linked to the growth of the money supply, and that if you can control the money supply you can control inflation. I could get into all kinds of details of Canada’s pointless failed experiment, but suffice to say, both the BoC and the Fed’s experiments with monetarism proved it wrong on two fronts: inflation and the money supply actually have a very weak if any connection, and you can’t really control the money supply anyhow. The system has been designed for banks to be able to determine demand for credit and provide it as they see fit, and market forces and the mechanisms of the central bank’s actions in the monetary system will simply limit the profitability of providing too much credit, but it isn’t designed to actually stop it cold.
I can’t remember if I concocted it myself or I heard someone on social media suggest it, but at one point I started to believe that maybe there was a connection between the adoption of monetarism and the BIS, that maybe at the same secret banker conference in 1974 where the Basel Committee happened, they also spoke of monetarism and promoted adopting it. So I start searching for “monetarism” in relation to the BoC, and in Hansard to see what MPs were saying about it.
(Brief side note, in the early 80s, as we prolonged the last gasp of monetarism, the champion of monetary reform challenging the assumptions and prescriptions of the flawed policies of the neoliberal monetary system was none other than a young Bob Rae as an NDP MP. I mean like bang-on amazing stuff, really blowing the bullshit of the system apart and questioning the very premises it’s based on. Truly heroic, what the hell happened?)
What I’m searching for is the roots of adopting monetarism in Canada, where did the idea come from and who might have influenced us to adopt it? Turns out it all begins with the growing global popularity of Milton Friedman and his contention “inflation is everywhere and always a monetary phenomenon”, thus plunging much of the world into an obsession with controlling the money supply in various ways to rein in runaway inflation.
Starting around the late 60s proponents of Friedman’s flawed and now thoroughly disproven theory started clamouring for monetarism to be adopted by central banks. The BoC, BoE, and Fed all had pressure building from economists and the financial community. There’s a book I dug up at the Toronto Reference Library, the Standing Senate Committee on National Finance report from 1971. In it there are details about debates at the Senate Committee between monetarists and central bankers, and while the committee seemed swayed by both sides, when you look into the testimony you really do see how the central bankers already saw monetarism was a flawed theory. Despite its flaws and the imposition of “a discipline that was market-based, impersonal, and above the reach of social forces” the idea was being bandied about everywhere for years, from the BIS, IMF, and many other neoliberal monetarist groups that Bank of Canada representatives participated in. None the less, pressure built up as inflation rose, desperation set in, and monetarism became the flavour of the day.
We voluntarily chose to adopt monetarism in 1975, while in 1976 the BoE was forced to adopt monetarism as a condition of a loan from the IMF, and the US came in last in 1979 under Volcker. I get the impression reading accounts from the BoC and BoE at that time that the adoption of monetarism wasn’t so much because they were confident it was the right prescription to cure inflation, but because it had basically become a financial market expectation and they were feeling pressure on all sides to conform.
Inflation expectations are a huge part of determining bond yields, which are intertwined with interest rates. Sometimes, or so the hope goes, you can dampen inflation merely by easing the expectation of inflation, so market participants stop acting as if the environment is inflationary. If adopting monetarism might settle inflationary concerns simply because the market is clamouring for it to be adopted, why not give it a go?
As I mentioned earlier, monetary policy and the monetary system are all a big evolving experiment, and there are many ways to skin a cat. Central banks and money markets tend to all work on the same principles across the world, but the structure and mechanisms in them vary in some interesting ways.
There are a few different ways one could attempt to control the money supply, and Canada’s version of monetarism didn’t involve directly controlling the supply of reserves in the system like the US did, but rather used interest rates to entice savers to move demand deposits into savings deposits, taking them out of the spendable money supply (for the initiated, the control of the money supply was trying to control M1 by using interest rates for people to move money in and out of M2).
The idea was that if people are saving their money they’re not spending it, and the drop in demand and consumption would ease inflation. The “gradualist” part of our approach was to have an announced target band for the growth of the money supply, and every year the mid point of the band would be lower and the range of the band smaller, gradually limiting the growth of the money supply. There were a few flaws in how the policy was determined and then applied, and how they measured the money supply and the results. Did it have the intended effect?
Well, it went horribly, inflation raged on, leading a decade later to the highest interest rates in history, peaking over 20%. As Governor Bouey said after winding down monetarism, “we didn’t abandon monetary aggregates, monetary aggregates abandoned us.” And it doesn’t matter if Canada’s handling of monetarism was done poorly or not, it was a flawed theory and a failed experiment and history and evidence have borne this out unequivocally.
So, out of a desperate bid to control runaway inflation in 1975 we adopted the Hail Mary of monetarism and wage and price controls, both eventually failing miserably, as inflation keeps rising along with interest rates. Let me repeat that, “as inflation keeps rising along with interest rates“. Now it’s time for some graphs.
Here it is, the classic “hockey stick” graph of Canada’s public debt. Just look at that horrifying skyrocket after 1974 and drool over how steady and low it was prior to that. As one site full of falsehoods quipped, “something sure went horribly wrong after 1974!”
So the problem with this graph, first pointed out to me in an email sent to COMER from David MacDonald of the CCPA, is that it’s not adjusted for inflation. You cannot compare money values across time, especially that long a time frame, without adjusting for inflation. It’s simply not accurate to compare a dollar in 2019 with a dollar in 1935. Here’s what it looks like in a proper context.
Suddenly WWII pops out in much more stark contrast, the climb after 1974 is not quite as steep, and the true depth of the Chrétien economic shock therapy cuts of the 90s is revealed. This is the only way to honestly look at a chart of our public debt, otherwise you’re comparing money in times of different values.
But there’s even more revealing ways to look at this information. We can look at the rate of the debt growth from year to year, to see when it was growing fastest:
When you view it this way you realize while there was significant growth in the 70s, it didn’t peak until mid-80s, which also coincides with the plunge in the monetary financing ratio featured in the Levy paper:
As you’ll soon see below, 1981 is when interest rates peaked over 20%. The question of what happened after 1982 is going to be the subject of another paper. Back to our debt…
So adjusting for inflation altered the graph a little, but there’s still a massive jump after 1974 to explain. Well, adjusting the graph for inflation doesn’t fully illustrate the relationship of the debt to the inflation. When you overlay inflation on the graph…
Well would you look at that, the inflation aligns almost perfectly with the rise in debt. Which makes sense, because ongoing high inflation would mean you’d need to sell more and more bonds every year because the money is worth less and less. But we’re not done quite yet, we haven’t considered interest rates.
Rising inflation means selling a greater quantity of bonds every year, but it’s also at a rate of interest, and when that is rising as well they compound each other into an exponential rise in debt. It is painfully obvious when you put the three on a graph and see how their peaks and slopes relate. The rise in debt was not some change in the policy of the BoC, it can be explained simply by the combined effects of rising inflation and interest rates on bond sales.
Now, one can argue the change in policy was the increasing use of interest rates to dampen inflation and that would be fair, but one must also consider the interest rates of the US. One of the many ways we are more or less forced to react to the moves of the US is interest rates, ours never vary too greatly from their’s, especially in those days. So whether or not we felt 20% rates were obscene, that’s what the US was doing and we are forced to follow suit or watch capital flight.
If one were able to accurately strip away both inflation and interest rates from the debt one would find it grows at a much more normal pace with growth of the population and the economy.
When it comes to understanding the history of the monetary system in Canada, 1974 is simply not the place to focus. To be sure the failed experiment of monetarism alongside wage and price controls is a relevant part of the history, but in terms of its effect on our debt or fiscal policy it is not significant. Of the various experimental monetary prescriptions of neoliberalism, from monetarism, to reducing monetary financing, to single-mindedly obsessing over inflation with punishing interest rates, one of the most significant neoliberal evolutions of the BoC was the elimination of reserve requirements starting in 1991. Which is an idea that DID originate with the BIS.
Banks in Canada were complaining about competition from other non-bank lenders that were not subject to reserve requirements. Well, this is of course a bit of apples and oranges, because non-bank lenders (excluding credit unions) do not have the power to create credit, they do in fact lend deposits. But the banks “convinced” (over $30 martinis in a Bay Street steak house no doubt) the government they were being treated unfairly, that required reserves were like a “tax on their money”, and they should be free to spend and invest instead of having that ability curtailed by money that was dead to them held in reserve. Well they got their way, and now both the BoC and BoE are 0% reserve systems.
(WONKS ONLY: Which in the end doesn’t really matter anyway, you can still conduct monetary policy in much the same way without required reserves, paying a deposit rate and charging the bank rate as the bottom and top of an operating band that constrains the cost of money).
In the end, as the title implies, 1974 and the Bank of Canada was much ado about nothing, at least as far as changes at the BoC goes. Yes we changed to a policy of monetarism, yes we instituted wage and price controls, yes we started the trend of rising interest rates, but none of that confirms any of the mythology. The simple truth is this:
That is truly the long and the short of it, there was no nefarious plot to sell the Bank of Canada to private interests or some change in policy that explains the meteoric rise in debt. Clearing up this history does not negate the need for reform, nor does it erase a past of more progressive liberal use of our public central bank, and it certainly does not disprove, in fact it illustrates, the rise in neoliberal thinking at the BoC. But the conspiracy theories need to DIE!
We are up against powerful corporate forces run by a psychopathic elite who do not wish to interrupt the profit vacuum we call an economy that has provided them such obscene levels of wealth. But we need change now, no longer merely for the sake of equality and providing the basic necessities of life for everyone, but because our planet is dying under the strain of our consumer consumption and resource extraction. It is truly as one of COMER’s co-founders Dr. John Hotson once said, “Could anything be more insane than for the human race to die out because WE COULDN’T AFFORD TO SAVE OURSELVES?”
Adam Smith, 21st Century