The Central Bank Dilemma - Easy Money vs Jobs vs Inflation

A Layman's Assessment. Blog 26.

Quantitative Easing is becoming the order of the day - QE1, QE2, QE3.... The bankers are being bailed out while the people are being left high and dry. Jobs are drying up, why can't all that money be applied to job programs? Part of the anger is being directed at the Federal Reserve System, otherwise called the Fed, which is the US central bank, for their involvement in the financial mayhem being unleashed in the US. Ron Paul wants to audit this august institution. We see the credit ratings for many nations on the skids including the US. The story of the Fed is so convoluted there is no way I can unravel all the issues - I need an easier assignment!

Canada is closer to home and the issues in principle are much the same, albeit the Canadian banking system is far more conservative and did not get quite so overextended. The public debt though is high when one includes the provinces, and unemployment is experiencing the same trends as south of the border. Free Trade has essentially made Canada a wholly owned subsidiary which is a worry for many and which can cause problems if foreign companies decide to pull production out of Canada. How much of this can be laid at the feet of Canada's Central bank, the Bank of Canada, hereafter called the BoC?

In Canada, there is a small political party, the Canadian Action Party (CAP), and a few others, that for many years have promoted the idea that the interests of the people are being strangled by the fact that commercial banks, instead of the Federal Government, creates most of Canada's money, and this is causing the government to fall into a debt trap, which could pose many dangers to our economy and even our sovereignty, despite Canada's abundant resources. Even in today's favourable interest-rate climate, Canadians pay more than $60 million PER DAY in interest on Federal loans, a big sum for a small country. Big enough to potentially solve many problems such as job creation, unfair student loan system, Canada's 3rd world Native reserves, etc. Since the BoC is owned directly by the Federal Government (unlike the Fed), the argument is that Canada could use the special powers of the central bank to alter the above scenario, effectively eliminating interest payments on the public debt, or more technically accurate, returning interest payments to the treasury as profits or dividends.

Advocates point out that our original BoC setup allowed us to survive WW2, build the seaway, TransCanada pipeline and highways, etc. The government nowadays plays a much greater role in the economy and our lives, but the claim, if verified, could be very significant.

Paul Hellyer, the founder of CAP, explains the idea, the essentials of which are the following main principles.

1. First "The problem with bank-created money (BCM) is that it is all created as debt ..... But no one creates any money with which to pay the interest, so .... [inevitably, periodically] A recession or depression wipes out a lot of debt so the whole process can start over again. " Readers may want to review his page or my blog on banking, to understand how the process of making a loan actually creates money within the banking system.
2. Next he takes aim at the change from a cash reserve system to "a so-called capital adequacy system that is basically uncontrollable because all of the yardsticks are subjective. It has got to go. "
3. "Next, bank leverage has to be reduced from 20-to-one to a level that the banks themselves would consider prudent if they were making a loan to industry. A ratio of three-to-one appears to be most appropriate. That leaves them with more than enough money-creation power to meet their legitimate objectives while denying the reckless latitude to finance leveraged buyouts, hedge funds, the purchase of stocks on margin, and the casino-like activities that have become addictive. "
4. "... the proportion of government-created money (GCM) should increase to 34 per cent of the total, while the banks (BCM) are reduced to 66 per cent from about 95 per cent. If the GCM is created as debt-free money, it will be possible to reverse debt-to-GDP ratios in every country. Of course, the 33-per-cent cash reserve should be phased in over a period of years to give the banks time to adjust to the new reality. Still, benefits of the transition would be immediate. "
5. "Whenever government-created money is suggested, the knee-jerk reaction of orthodox economists is that it would be inflationary. That is not correct. It is the quantity of money put into circulation that influences prices, not who prints it. GCM would be entirely neutral if BCM was reduced accordingly. "

I can't vouch for the numbers, but this makes a great deal of sense, especially the idea of cutting back on the casino-like speculative operations that banks have gotten into. So much so that I decided to try to raise the issue by representing this 'fringe' party during the recent Federal elections. Such an idea might seem preposterous but keep in mind that unlike the US, which established its central bank in a secretive and manipulative process in 1913, Canada's CB was an election issue before and after its creation. As a candidate however, I thought that I should undertake a 'due diligence' review of the above ideas-- an independent, first principles examination, albeit as a layman in such matters.

I had various concerns. I felt that some of what was being said by promoters had a dubious 'free lunch' aspect, which, combined with a blogger's inflation accusation and my rather tentative reply convinced me that I needed to dig deeper. It is important to make sure that this proposal is not a ruse to trick the public into giving politicians what they always want: money with no strings, no apparent taxpayer pain - a prime recipe for wars, such as Bush's strategy of invading Iraq while cutting taxes. Also, my acceptance of the idea and decision to promote it rested on the presumption that it was simply restoring a historical reality, rather than an invention of something new-- but was this correct? Fooling around with the currency of a nation is not to be taken lightly. My study is belated, but hopefully, better late than never.

To familiarize myself with this subject, I borrowed Where the Buck Stops by Babad and Mulroney from our public library. They describe the origins of the BoC in a lively historical format, which gives good insight into the origins and nature of Canada's unique Central Bank and the forces that shaped it. I'll be frequently referring to this book and will call it simply the Buck book! I'll refer to the authors as B&M.

This will be a series of approximately 15 segments. In the next episode, I'll present an overview of government created money (GCM), historically and in other jurisdictions and identify the main issues.

In case you wondered where the 'blog 26' came from or how you got here from my original blogsite, I decided to migrate my blog here after my initial blogsite got full!! I'll continue to use robertinnes.ca as a master index and for special purposes as yet unknown.

I'll add links as sections are posted/published. There is a navigation aid at the end of the page but I noticed that it seems to run backwards. Forward seems to be to the left and not the right. I'll be looking into this. Thanks for your patience.

2. Historical Examples

• Basic issue - monetary discipline vs full(er) employment

3. The Technicality - Was the free money free.
4. Definitions & BoC functions
5. BoC's Dilemma - inflation vs jobs

• Discussion
• Why not a Gold Standard?

6. Canada's Central Bank - History and Development

• BoC Beginnings
• BoC Independence .... moving to
• Joint Responsibility system - sort of.
• Total Nationalization - New Zealand's system
• Milestones
• BoC mechanics, bonds, etc
• Bank Supervision

7. Synopsis of how monetary policy works in the economy, charts. This section may take awhile to publish. Please bear with me.
8. How Monetarism Screwed Us All

9. 'Governmint' made money - safe or not?

• Caution Needed on GMM
• Can loans be paid back if the interest portion wasn't created by banks?
• Monetary Froth Must be Eliminated
• Tackling the Debt
• Social Asset Model

10 Blackbeard and the Bankers

• Globalism Super Bubble
• Banksters
• Radical Perspectives

11 A Small Central Bank, An Avalanche of Fuddle Duddle

• Externalities
• Peak .....
• EnviroHell....
• QE.....

12 Personal Ruminations
The Future
References
Work Needed
Afterword

Note: Not being sure how the formatting will turn out, I've decided to post (publish) the first half of this study and add sections as I go along. Please forgive any confusion this causes. I'm hoping that any comments can be incorporated more easily in later sections. Thanks.