Bank of Canada: Provincial and Municipal Financing Policy

Whereas:

The Rooseveltian banking reform, which became the model throughout much of the Western world, provided an alternative to raising the benchmark central bank interest rate in the statutory reserves that banks had to redeposit with the central bank from the deposits made with them by the public.

However, particularly since the 1970s the banks, having cleaned up their balance sheets during the years during which they were restricted to banking, were lobbying for further deregulation and globalization. By the 1980s in particular, they lost much of their capital in their involvement with mortgages, and to bail them out from their plight, the Bank for International Settlements -that conducted the comeback plans of the world's banks, the BIS brought in its "Risk-Based capital requirements" for banks of developed countries that declared government debt of such governments to be "risk-free" hence requiring no down payment for the banks to acquire. As a result the Canadian banks increased their holdings from around $20 billion to $100 billion.

The elimination of the statutory reserves between 1991-3 left the benchmark interest rate the only device for the central bank to dampen or stimulate the economy. And that awarded unique control position of the economy to the speculative financial sector, whose primary revenue is interest.

The BIS, and all the central bankers, around it overlooked a detail. To fight inflation that could be expected from such a great infusion of capital into the banking systems, the BIS raised interest rates to the heavens, proclaiming what to be "zero inflation" -i.e. an absolutely flat price level as alone acceptable. But with the banks loaded up with completely leveraged government bonds issued earlier with drastically lower coupons, the banks suffered a massive loss. This caused a major monetary crisis in Mexico that threatened to bring down the world financial system. Mexico's banks closed their doors and , though only recently privatized again, once again were taken over by the government. Eventually 85% of the banks of that proudly nationalist country ended up under foreign control.

The Mexican banking crisis was prevented from bringing down the world banking system, an emergency fund of $51 billion was put up by the USA, the IMF, and Canada. It was not used, but the United States government had learned an important lesson.

It became clear that the age of sky-high interest rates was over. For the deregulated banks were in no position to forgo the mountains of government debt they were now authorized to acquire with no down-payment.

A way out was devised by Robert Rubin, a Wall Street alumnus. With very few exceptions, governments of  the day did not keep their books according to the double-entry system supposed to have been brought back from the Near East by the Crusader about a thousand years ago. That requires that each transaction enter the firm's ledger twice: once as the value of a given acquired asset depreciated over its likely period of usefulness, and then the amount of money paid for it amortized over a reasonable period. That is known as accrual accountancy or capital accountancy; the system by far most governments employed as "cash accountancy". By this the debt incurred for the acquisition was carefully amortized over the term of its financing, but the value of the asset was written off in the year when the transaction was concluded. Obviously that left a deficit that was not really there. Private firms employing such bogus accountancy would find themselves in deep trouble when the tax sleuths caught up with them. But the fictitious bookkeeping of the governments themselves had considerable strategic advantages. It bolstered the argument, that we cannot afford social programs, and above all it made for some handsome privatization deals when highly expensive real estate or other infrastructure booked at a minute portion of its real value.

The Clinton government got around that difficulty when it switched to accrual accountancy and replacing $1 dollar token value with a properly amortized value of the asset, and working the conversion back to 1959 came up with some $1.3 trillion dollars of greater asset value. That first appeared in the Secretary of Commerce's book in January 1996, but under the headings of "Savings", which economists apply only to cash or assets readily convertible into cash. However, a nudge and a wink to the appraisers, who we know from the current sub prime investigations to be highly obliging folk did the job. The lower interest rates that ensued from the revelation of so much net value in the government's estate brought in a low interest area that gave Clinton a second term rewarded the nation with the prolonged technological boom that burst only as the new millennium had its foot in the door.

How dear the bogus low pricing has been to the private financiers appears from the persistent refusal to bring in accrual accountancy in Canada, even though the Auditor-General refused to sign off on two annual reports on government financing. Finally a sordid compromise was reach when the government switched to accrual accountancy, but only when it had elicited a degrading statement from the A-G to the effect that since no new money had entered the Treasury as a result of the agreement; it should not be taken as a reason for expenditures on new programs.

However, when the successive bailouts of our banks had left holes in the federal treasury the federal government had downloaded crucial social programs onto the provincial government without the revenue to pay for them, a compliment that the provinces lost no time in passing on to the municipalities.

That is the origin of the potholes in our roads, and the violence in our schools.

Therefore:

We must ask that serious double-entry accountancy be brought into the finances of the nation. The Bank of Canada must be used for the purposes for which it was nationalized in 1938, at a good profit for the 12,000 private shareholders who had held their shares only for some four years. Both the federal and provincial governments are eligible for financing both their funded and unfunded debt in generous amounts. Municipalities, as corporations, can with guarantee either of the federal or of a provincial government.

The interest paid on such loans, of course, would come back as dividends only to the federal government which is the Bank of Canada's single shareholder. But the federal government could reach a fair arrangement with the province or municipality that may have used Bank of Canada financing. It would straighten out the tangled financial relations of the different government and help usher in a happier period in the relations of our various levels of government.