Wednesday, October 01, 2008
The Money Meltdown
If Jack Layton is to deliver on his promise "to protect Canadians with new banking regulations" (Sept. 17, Welland, ON), hell need to pay close attention to what has happened and what is now happening at the Bank of Canada.
When I say the Bank of Canada, I mean OUR bank the peoples bank, the only publicly-owned central bank in North America. Nationalized in 1938 by the government of the newly-elected prime minister, William Lyon MacKenzie King, this bank has served Canada well. It funded a war effort, a seaway, a trans-Canada highway, old age pensions, and universal health care. All of that without serious inflation and all interest-free, because any profits were paid into our national treasury.
Until the early 1970s, all private banks were regulated. Their restrictions involved reserve requirements, limited loan periods, and maximum interest rates. Since then, each of these restrictions has been removed. Since 1972, private banks have created money by extending credit to governments at every level and always collecting for themselves the going rate of interest. The total annual interest charges for these municipal, provincial, and federal debts are now over $60 billion annually.
With relaxed regulatory controls, the privately-owned banks have taken full advantage of the opportunity to inflate the money supply by creating credit instruments for investors backed by assets of questionable value. Such "assets" include sub-prime mortgages, auto loans, and credit card debt. Canadians have been encouraged to imitate their American neighbours in this folly, borrowing well beyond their ability to repay. Canadian businesses and investors have suffered as a result. Some $33 billion of Asset-Backed Commercial Paper (ABCP) has been frozen since August, 2007. The supposedly risk-free ready cash is still not accessible.
Oh, wait! Maybe it will be. The solution proposed by the Purdy Cameron Commission (composed mostly of bankers) is for the Bank of Canada to loan these private for-profit banks money to pay off their debts, using only their ABCP assets as collateral. This proposal has already been approved by a Toronto court (though is subject to appeal). In the past, it would have been illegal, but the Bank of Canada Act has recently been modified so the transfer can happen. Under the new law, the Bank of Canada now can provide 365-day loans based on questionable, high-risk collateral, whereas previously only first-class collateral (e.g, Government of Canada Treasury notes) has been acceptable, and only for overnight loans to private banks. Is this collateral really worth a dollar? In August, the National Australian Bank, which also owned this type of questionable high-risk collateral, wrote down their holdings to 10 cents on the dollar.
In other words, in order to rescue the private banks from their self-created crisis, the Bank of Canada OUR public bank is now primed to offer "good money for bad." This essentially mimics what has been occurring in the U.S., where the "Fed" (in that case, a privately-owned central bank) has accepted collateral of similarly questionable value to extend 100's of billions of credit to protect the banking system. What are the implications of such a move? Initially, the effect will be to reduce public panic, promise some return of capital to investors, and keep the private bankers in business. But ultimately, the financial consequences will be enormous and at the expense of everyone in the country.
When you pump money into the economic system without equivalent resources backing it, the result is serious inflation. As the value of our money deteriorates, we can buy less because we must pay more for everything we buy. The latest statistics from recent issues of The Economist, more reliable than those from Stats Canada and the Bureau of Labor Statistics, document the double-digit price increases we are even now experiencing.
But most importantly to the economy as a whole, this crisis will generate serious consequences for the banking industry. It is imperative that government use this opportunity to modify the practices of the private banks, and act immediately to reinstate a forceful role for the Bank of Canada. We should note that in a similar situation in Norway, the government chose to nationalize the failing banks rather than bail them out. If we are to protect the long-term interests of businesses and consumers, we must act decisively to limit the power of private banks and control the creation of money.
The need is clear: We must challenge Jack Layton and ask him if his MPs will have the wisdom and courage necessary to make the necessary changes in our monetary system. We must ask if the Liberal and Conservative parties MPs are willing to risk cutting off their private-banker support and finally act in the public interest. We must ensure that this subject becomes a primary topic in the leader debates and insist that the new government take immediate action.