More myths have been spun around the issue of government debts and deficits than around any other matter of public policy.

We have been led to believe that Canada has sunk deeply and dangerously into debt because "we have been living beyond our means." We have been told that the financial crisis was caused by our demands for "lavish" public programs and services that the country really couldn't afford. We are warned that, unless governments drastically cut spending on these services and curb our "unhealthy" dependence on them, Canada could "hit the debt wall." No one would lend us money any more. Our standard of living would fall to Third World levels. "Is this the kind of legacy," we are asked accusingly, "that you want to leave your children?"

With this grim scenario pounded into us day after day, it's no wonder that most of us have been persuaded that getting out of debt must be our governments' No. 1 priority--no matter how much it hurts the poor, the weak, the jobless, the disadvantaged. We've become resigned to all the cutbacks that have been imposed on us in the name of deficit reduction. "It's for your own good," we're assured. "Your children and grandchildren will thank you for not passing on all this debt for them to pay off." Some of us may wonder if our children will really be thankful for standards of health care, education, unemployment insurance, and other public services that are much lower than we enjoyed. But our concerns are dismissed by the "experts" in politics, in business and in the media. They promise us that, when all the public debt is paid off and we get back on a sound fiscal footing, prosperity will return and everybody will be better off. Increasingly, however, more and more of us are beginning to doubt these glib assurances. We see interest rates staying unreasonably high, and government debt rising as a result, and we doubt whether all this debt was really caused by government overspending. We see profits soar for the banks and large corporations while more and more of us have our wages frozen or even lose our jobs, and we doubt that the deficit-reducing pain is being equitably shared. These doubts are well-founded. Most of the things we've been told about public debt and deficits are simply not true. But it's important to the wealthy and powerful elite who concoct these myths that we continue to believe them. Because, as long as we believe them, we'll keep on accepting the hardships being imposed on us.

We won't like the high interest rates. We won't like having so many people out of work and so many of them being cut off UI. We won't like the growing poverty and destitution that afflict millions of us, especially the impoverishment of growing numbers of children. But we'll grudgingly accept all this misery as an atonement for our past sin--the sin of demanding so much "coddling" from our governments that we forced them to borrow excessively to feed our dependence.

The politicians, the business executives, the bankers and the stock market speculators profit from the guilt they have made us feel. It enables them to grab an increasingly larger share of the national income. They have fed us many myths about public spending and debt to reinforce our feelings of guilt and repentance. As long as we can be made to think we are to blame for the financial mess our governments are in, the politicians, business leaders and bankers who are really responsible for the debts and deficits will continue to enjoy their power and affluence--at our expense. They don't want us to find out that what they've been telling us about government finances is false--that what we have come to regard as self-evident facts are really myths. They know that, if we uncovered the truth, we would no longer passively allow them to tear down our country's most cherished programs, values and institutions. The deficit is their all-purpose excuse for this devastation. Without it, they would be seen to be dismantling our welfare state solely for the purpose of enhancing their own wealth and power.

We can't ignore the deficit or the debt. The horrendous debt-servicing costs are draining billions from government coffers that could otherwise be put to constructive use. But we have to focus on the real causes of this fiscal problem and come to grips with them, instead of scapegoating and dismantling the welfare state.
At the centre of the deficit debate is a political contest for the hearts and minds of Canadians--a struggle to influence and control public opinion. With much at stake, powerful groups do not hesitate to throw their weight around. Corporations finance political parties: both the Liberals and Conservatives receive over 50% of their funds from business. Corporations sponsor "think tanks" such as the C.D Howe and Fraser Institutes to promote their preferred economic issues. Most importantly, corporations own the media. At various times, corporations have targeted international competitiveness, inflation, and the deficit as their major concerns. Interestingly, they see reducing
government spending as the best way of dealing with all of these problems. For the wealthy, inflation is regarded as a form of theft. It reduces both the capital value of their stocks and bonds, as well as the income derived from them. On the other hand, high interest rates, the preferred instrument for fighting inflation (along with government spending cuts), enable them to fatten their income gains.
Perversely, however, trying to reduce the deficit through government spending cuts and fighting inflation through high interest rates tend to weaken the economy and thus increase the deficit and the debt. In fact, these very policies have been followed in recent years, and they have produced a weaker economy, as well as a growing national debt.

When real interest rates exceed the rate of economic growth, the debt grows faster than the ability to pay it down, because government tax revenue can't keep pace. Governments then resort to borrowing more just to meet the interest payments on the national debt. This spiral of rising interest payments, leading to a growing debt, poses a serious problem for public finance. But further spending cuts, supposedly to reduce the deficit, only make things worse, since they reduce the capacity to repay the accumulated debt.

Canadian governments have not "overspent" on programs and services, either in actual terms or in comparison with other countries. In 1994-95, for example, the federal government collected $123.9 billion in revenue, while spending $119.1 billion on services and programs, leaving an operating surplus of $4.6 billion. An even larger operating surplus was projected for 1995-96, this time $11.5 billion. This is not unusual. Spending on programs in Canada has rarely exceeded government revenue since World War II. In fact, the deficits incurred on program spending since 1975 total just $67 billion--a relatively small percentage of the total accumulated debt. Nor has our federal government spent more on programs and services than most other countries. The latest OECD international comparison in fact shows that Canada spends less on social programs, as a percentage of its GDP, than do 13 other countries, including "poorer" nations like Greece and Spain. Canada's social spending reached a peak of nearly 19% of GDP in the depths of the 1991-93 recession, but has since dropped to about 16%. It is projected to fall even further, to 14%, as a result of the Liberal government's massive funding cuts--those already made and those planned in future budgets. Our social programs, far from being overly generous, are inferior to those elsewhere in the developed world, as shown in the annual OECD surveys. Our unemployment insurance system, for example, ranks 15th in benefits among OECD countries. In France, which devotes 28% of its GDP to social spending, subsidized child care is available to all children under the age of 6. In Sweden, women get a year's paid maternity leave with their jobs and benefits guaranteed. All the European countries, in fact, provide a better and wider range of social services than does Canada.

A Statistics Canada study found that government spending, far from being the main cause of Canada's accumulated national debt since the mid-1970s, was responsible for only 6% of it. The chief culprit is the Bank of Canada and its decision since the early 1980s to maintain excessively high real interest rates. Prior to 1982, real interest rates--the rate of interest charged above the inflation rate--averaged only about 2%, and often went lower. (In the late 1970s it was below 1%.) Since then, it has averaged more than 6% and on occasion has reached 8%. The result has been to raise the cost of borrowing for everyone, including Canadian governments. That's why, despite spending less on programs and services than they receive in revenue, they have still run up huge deficits: because of the effects of compounding interest payments.

The reason the federal government recorded a $39.7 billion deficit in 1994-95, instead of a $4.6 billion surplus, was because of the $44.3 billion it had to pay the banks, bondholders and foreign money-lenders in interest that year. For 1995-96 its interest payments were projected to be $47.3 billion, wiping out what would otherwise be an $11.5 billion surplus on program spending and creating a budgetary deficit of $35.8 billion. In February 1995, the Dominion Bond Rating Service released a study which attributed the vast majority of the federal debt--93% of it since 1984--to compounding high interest rates. The study noted that, between 1984 and 1994, the federal debt ballooned from just $94 billion to a staggering $508 billion, primarily "due to the compounding interest on the relatively modest program expenditure deficiency." It is these sustained high interest rates, the bond rating agency concluded, "which are driving the deficit today."

To illustrate the key role of interest rates, we need only compare the effects of borrowing $1 million at 2% (the historic level of real interest rates) and borrowing the same amount at 10%. At the reasonable 2% rate, it would take 36 years of compound interest for the $1 million to double to $2 million. But at 10% interest, the same loan doubles in just seven years. In 36 years it would double and redouble five times to $32 million. The irony of the current debate is that those who say the elimination of the deficit should be the overriding priority for government ignore the inexcusably high real interest rates, and the destructive effects of compound interest, and instead favour policies which will ultimately worsen the deficit. Those who argue for lower interest rates (along with more job creation and fair tax reforms) actually have policy alternatives that will bring the deficit spiral under control.

Federal government spending on programs and services has been growing more slowly than all other spending in the economy. Measured by this spending, government is shrinking. By 1996-97, government programs are projected to be a smaller share of all spending than at any time since 1947. It makes no sense, therefore, to talk about government spending being out of control. It helps to remember that government spending is an important component of national income, because most of it consists of transfer payments to individuals and other levels of government. This money is largely spent on the purchase of goods and services, which creates jobs. Cutting government spending thus lowers national income, which in turn lowers employment. It is estimated that a drop in government program spending of one billion dollars leads to the loss of between 20,000 and 30,000 jobs elsewhere in the economy. A cut in government spending of $1.00 does not in fact lead to a reduction of $1.00 in the deficit. Why not? First, because a portion of the unspent dollar would have come back to the government in taxes. With an average tax rate of 25%, the amount saved by the spending reduction of $1.00 thus falls to 75 cents. Second, the spending reduction has an impact on the rest of the economy: it leads to lost employment and income. Some additional spending becomes necessary to pay for the income support of those who have lost their jobs. The government may find itself spending as much as 40 cents out of the dollar on various kinds of social assistance. Third, the dollar not spent by the government represents lost income for local grocery stores, other small businesses, and landlords. They not only pay less in taxes as a result, but they may also decide to cut back on their own spending for goods and services. This precipitates a vicious circle, in which government cuts lead to lower national income, followed by less business spending, which in turn leads to a further fall in national income. The experience of the Great Depression taught us that government has a responsibility for the overall health of the economy. Falling prices and incomes caused a cumulative economic decline, because low wages could not lead to more employment, nor could low prices encourage increased consumer spending. Breaking out of this vicious circle required increased government spending: investment spending and consumption spending. Without a boost from government policy, the economy would stagnate. The remedies for falling prices and incomes were: first, to use government spending on programs and services to get the economy growing; second, to use taxation and social spending to redistribute income towards people who would spend it; third, to use government investment to create jobs directly; and fourth, to ensure that affordable credit was available to finance both public and private investment.

These remedies are as appropriate today as they have ever been. (This article is an excerpt from "10 Deficit Myths," a new 40-page booklet which Duncan Cameron and Ed Finn have co-authored and which can be obtained for $5 a copy from the CCPA.)
Taken from The CCPA Monitor, February1996.
Canadian Centre for Policy Alternatives

 The latest  Annual United Nations Development Report/UNICEF 1997 and WHO 1998$40 BILLION A YEAR
It is estimated that the additional cost of achieving and maintaining universal access to basic education for all, basic health care for all, reproductive health care for all women, adequate food for all, and clean water and safe sewers for all is roughly $40 billion a year--or less than 4% of the combined wealth of the 225 richest people in the world.
1.3 billion people in the world today (1,300 million, or 1,300,000,000 people) struggle to survive on $1/day.
3 billion people in the world today struggle to survive on $2/day.
2 billion have no access to power (electrical).
The net worth of 10 billionaires, ten human beings, is greater than the combined national income of the forty-eight poorest countries combined.
In the West, 100 million people live below the poverty line.
Globally, one in five people do not expect to live beyond the age of 40.
Three out of four in the poorest countries will not see their fiftieth birthday
About 300 million people live in 16 countries where life expectancy actually decreased between 1975 and 1995.

THE CAPITALIST HOLOCAUST: More than 15 million adults aged 20 to 64 are dying every year. "Most of these deaths are premature and preventable." (WHO)
The gap between the poorest fifth of the world's people and the richest fifth has increased from 30:1 in 1906 to 78:1 in 1994.
The world's 225 richest individuals, of whom 60 are Americans with total assets of $311 billion, have a combined wealth of over $1
trillion--equal to the annual income of the poorest 47% of the entire world's population.
Debt relief for the 20 largest 3rd world "debtor nations" would cost $5.5 to 7.7 billion, the cost of a couple of stealth bombers.
In 1996, sub-Saharan Africa paid the developed world $13.4 billion, including $9.5 billion in new loans and $2.6 billion of its aid (23
percent of all grants). So nearly a quarter of aid to Africa simply goes to repay debts.
Developing countries paid $270 billion in debt service last year - $60 per person. This has risen from $160 billion in 1990.
Americans spend $8 billion a year on cosmetics--$2 billion more than  the estimated annual total needed to provide basic education for
everyone in the world.
Europeans spend $11 billion a year on ice cream--$2 billion more than the estimated annual total needed to provide clean water and safe sewers for the world's population.

MELTDOWN
ER9902-#1 COUNTERATTACK: AVOIDING THE BOOBY-TRAPS
   The following text is an abridged and updated version of the presentation given by William Krehm, editor of Economic Reform and chairman of COMER, on Wednesday, January 27 in Toronto. This was to launch the publication of Meltdown, COMER Publications latest book.
Please see full details on the book and how to order at the end of This message.
mailto:wkrehm@ibm.net
===============
COUNTERATTACK: AVOIDING THE BOOBY-TRAPS By William Krehm

       The art of talking in riddles if persisted from lofty enough pulpits can end up letting the black cat out of the bag. That is increasingly the case with Alan Greenspan, Chairman of the US Fed. Appearing before the House Ways and Means Committee (The Wall Street Journal, 21/1) he was astoundingly outspoken, "Policymakers should avoid actions that undermine confidence and interfere with the effective allocation of capital. [He] startled some committee members by urging them not only to reject Mr. Clinton's proposal to lift the minimum wage by $1 to $6.15 an hour, but to lower or repeal the minimum wage. ‘I think it does more damage than good.'"

        But (on 29/1) the same publication reported Mr. Greenspan before the Senate Budget Committee saying that "he [had] figured out what is driving the mania for Internet-related stocks: the same not-quite rational impulse that drives millions of people to pay more for lottery tickets than they are worth. Is there hype in this? There is hype in a lot of things...with all the hype and craziness, it's something that, at the end of the day, probably is more plus than minus.'"

        But Mr. Greenspan evaded the real question. Is it fitting for our banks and other financial institutions who have been assigned most of the money creating powers in our society to gamble on lotteries when their losses are in effect underwritten by the taxpayer.

        Greenspan's current utterances are a far cry from his position in December, 1996 "when he famously warned of ‘irrational exuberance' in markets in December 1996 -- a time well before Internet mania. The Dow Jones Industrial Average has zoomed ahead about 45% since then. "Internet stocks -- involving marketing by the Internet -- have no earnings, have been known to jump by hundreds of percent in market  value within hours of being issued. Yet Mr. Greenspan was warned in no uncertain terms to butt out in his comments on stock market levels,  and to concentrate on fighting "commodity inflation."

        This amazing contrast between the Fed chief's indulgence towards the hyperinflation of asset values, and the proposals of the Clinton government to raise the minimum wage takes a considerable effort to understand. The missing clue is to be found the concept of the  "dominant revenue" formulated by the late French economist Francois Perroux in the sixties. This holds that in every society the revenue of a particular economic group is seen as the "dominant revenue." By its rate and volume is it accepted as the measure of society's well-being. Before the industrial revolution, the dominant revenue was the rent of land-owners.
Then it became the profit of industrialists. After the depression of the thirties the dominant revenue depended on the cooperative investment of the state and private industrial capital, with the trade unions as junior partners in that alliance.

        At the time Wall St. and the banks were in the dog-house because of their major part in bringing on the Great Depression. As the price for bailing them out, the Roosevelt government put severe ceilings on the interest rates banks could pay or charge, and what they could do with the money they created or took in as deposits.

        On this regime the banks recovered, and came to lust after the old flesh-pots. By 1951 the Fed-Treasury Accord in the US weakened the ceilings on interest rates, and launched the banks on the comeback trail.

        The critical turning point came in the sixties. In that decade the new society promised during World War II was actually being put in place.
The financing of the war and the first decades of the peace had proved it possible to run the economy without periodic depressions. The theory for that had been worked out by John Maynard Keynes and others in the thirties, but it took a world war to put it to a bold test. The  postwar depression that just about everybody expected had been avoided. Canada welcomed a huge penniless immigration and housed it to standards undreamt of before. By the sixties as the baby boom generation approached college age, post-secondary campuses sprouted across the  land like mushrooms. Health and social security systems were put in place.

        But the sixties were also a period when prices started inching upward.
That was no accident, given the amount of essential public investment underway. But instead of analysis, the traditional wisdom of the early thirties took over. Panic about inflation was whipped up by those who had every interest in doing so.

        There was a more relevant explanation for that mild price rise. The new educational and social services were not marketed, but paid for out of taxation. That could only swell the layer of taxation in price. The costs of the new social services entered the price index through that taxation. Their benefits, however,were not picked up by the price index
-- for the same reason that you can't read the temperature on a barometer, or the air pressure on a clock. By definition, any unadjusted price index must be blind to the benefits of unpriced services.

        If so unquestionable a relationship is ignored by policymakers for decades, it does not lose importance. Its importance goes on increasing until it attains crisis proportions.

        The policy of pushing up interest rates to flatten prices had to be self-defeating. For interest is a key cost in an economy that has been becoming more capital-intensive by the day. Prices can be brought down by high interest only by bringing down the economy itself.

        What had been learned at a shattering cost during the Great Depression could not be buried overnight. At the time there was a considerable national diversity in economic theory. Apart from the powerful French school, Scandinavian economists in some respects anticipated Keynes' ideas. The German historical school delved into history for its  economic generalisations rather than sucking them out of some irrelevant mathematics. The self-balancing free market school that neutered Keynes, was a distinctly American invention. American economics -- the so-called Washington Consensus -- through its control of the international organisations has gobbled up not only these diverse national schools but the very memory of them. A militant free-market orthodoxy has been imposed throughout the world. It singles out inflation as the one  menace and high interest rates as the one cure.

        The more experience disproved that dogma, the more sweeping the campaign grew to impose it. It was like allowing the patients in an anti-addiction clinic to prescribe the therapy. Every alternative to high interest rate for dealing with real inflation was suppressed. Previously it had been possible to deal with an overheated by raising the reserve requirement. That forced the banks to lend less but at  rates no higher than 6%. To defend the currency, exchange controls had been resorted to from time to time. Today for that purpose we push up our interest rates to attract hot foreign money.

        Perroux's theory of the "dominant revenue" explains why this was possible. Interest rates are the revenue of an economic group not devoid of appetites. That raises an obvious conflict of interest that was never addressed. If you rule out all other ways of handling monetary problems and proclaim interest rates the one blunt tool in your kit, what you are setting up is not a free market, but the monopoly of a single revenue.

        The people who ran this show were not out to win academic brownie points. The more disastrous the policies, the more they tightened their grip on what was taught or published. If you plot side by side the  major disasters of the "zero inflation" policy and the stepping up of the dosages of that policy, a clear correlation emerges.

        By the late seventies interest rates, feeding into costs and prices, rose ever more quickly. So the remedy chosen was to push up rates still higher. But to hide what it was up to, the US Fed announced that it  was no longer concerned with interest rates. It would rein in the money supply and let the interest chips fall where they may.

        However, because of the deregulation already pushed through, no one could say what the money supply might be. The money supply had been defined as money held for transactions. This was always taken to  consist of cash and non-interest bearing chequing deposits. But the Fed had recently introduced chequing accounts that did earn interest.  Naturally, with high interest rates spreading uncertainty, a lot of money was parked in these new hybrid accounts. The Fed chairman,Paul Volcker, suddenly noticed that the deposits in them had jumped sensationally.  At a loss what to do about it, he panicked. And when a banker panics his knee-jerk reaction is a to raise interest rates. So interest rates were pushed up to well over 20%. Those rates ransacked government  treasuries throughout the world, and bankrupted businesses. But once again the cure was more deregulation and hidden subsidies to the banks.

        Before coming to the Bank of Canada, Governor Crow had spent his entire career with the International Monetary Fund, mostly in Latin America.
He brought to the BoC an imperial manner up to then reserved for wretched Third World countries. The fact is that when statutory reserves were done away with in Canada, only the UK and Switzerland among major countries had also done so. There was not the remotest reason for Canada to have ended reserves except John Crow's ambitions as superachiever. And of course it had become urgent once again to bail out our banks.

        That rescue came from two different directions. In the late 1980s the Bank for International Settlements (a sort of central bankers' club) published its guidelines for Risk-Based Capital Requirements. These declared the debt of developed countries risk-free. It could therefore be hoarded by banks without tying up any of their capital. Business loans on the other hand required 8% of the bank's own capital. That enthroned money-lending as the dominant revenue. In Canada that was accompanied by the phasing out of the non-interest-earning reserves  that banks had to put up with the central bank as a proportion of the deposits they held. Between the two measures banks were able load up with another $60 billion of government debt without coming up with a penny of cash of their own. To make room for that, the Bank of Canada obligingly reduced its own holdings of government bonds even in  absolute terms.

        This amounted to an annual entitlement for the banks of at least $5 billion. That amounted to about 80% of the entire slashing of grants by Ottawa to the provinces for social services. When the central bank holds government debt the interest paid on it finds its way back to the government as the sole shareholder of the bank in the form of dividends. When the chartered banks hold the same debt that interest stays with them.

        By 1992 the zero inflation policy had clearly become one Huge disaster. But did the government and the Bank of Canada soften its position? On the contrary. In defence of the "dominant revenue," they behaved exactly like the garrison of a besieged fortress. They moved to put zero inflation into the constitution and the Bank of Canada Act, as well as the independence of the central bank from the government. That would make the disastrous policy practically irreversible. All three caucuses of the Banking Subcommittee of the Commons turned down the proposal, but that was not even reported by the media.

        Deregulation and the two measures I have just described, changed even the food chain of our banks. They were allowed to take over brokerage houses, underwriting firms, derivatives boutiques. From being interest-driven, our banks have become stock-market-dependent. Imperceptibly, the dominant revenue has shifted from interest to speculative profits. Without the dominant revenue concept, it would be hard indeed, to pick up that crucial shift.

        There is a vast difference between the interest rates and Speculative profits as dominant revenues. High interest rates are poison to stock markets. The private institutions that have taken over money creation are not just in control of the gambling joints but are their own biggest customers. They have acquired command of the public treasury very much in the way in which they financed the Leveraged Buyouts of private corporations. First they loaded it with high-interest debt, and then downsized government services. When the deficit has been pushed high enough it took over from inflation as the driving bugbear.

        That set the stage for the privatisation of government assets at fire sale prices. Indeed the bizarre accountancy of our government makes it impossible to say what a public asset is worth. When a physical capital asset is acquired by Ottawa it is written off in a single year and entered on the balance sheet at a token $1. Because of that the government could sell the St. Lawrence Seaway or the Parliament Buildings for one thousand dollars, and book a profit of $999. Then in front of the TV cameras that could be patriotically applied to reducing the debt. And then the buyers can lease the asset back to the government at a fair market rate and list it on the stock exchange to make a further killing. Capital budgeting (full-accrual accountancy ) has been recommended by Royal Commissions and accountancy associations for almost forty years. But nothing has done about it.

        Economic Reform compiles a statistic from data in the Bank of Canada Review -- the proportion of the chartered banks' assets to the cash held by them. That basically continues the credit-creation multiplier fromthe period when reserves still existed. That ratio has increased from 11in 1946 to 363 today. But even that doesn't tell the whole story. The assets for the most part are evaluated at their historic cost -- i.e.what they paid for them, not their present market value. If the assets -- that may include Indonesian bonds, chunks of Thai, Mexican and
Venezuelan banks -- were to shrink across the board by 5%, our banks would have lost all their capital. That is exactly the position of several of the largest Japanese banks that our banks have been so determined to emulate.

        Soon the banks will be back for the next bailout. What form can that bailout take now that the reserves have been done away with?

        Trial balloons have already been launched that may provide the answer to this question. In Mexico legislation has actually been passed providing for the restoration of reserves up to a certain amount, but on these reserves the central bank will pay the banks the going rate of interest. Something of the sort has been broached by certain of the central banks of the constituent countries of the Euro union.

        If that is allowed to happen, negative seigniorage will flow to the banks from the government for having assigned to them its powers of money creation. Of course, this would increase government deficits and usher in a new period of slashing public services.

        When the banks come to the government for the next bailout, we propose a quite contrary course. Non-interest-bearing reserve requirements must be restored. High interest rates must be abandoned as a means of controlling inflation even where it really exists. Instead the restored reserve requirement can be raised to cool the economy and or lowered to make more credit available in the event of a recession. Currency crises can be defused with temporary exchange controls. Barriers must be set up to brake the flow of hot money across frontiers.

        The funds for bailing out what banks merit being bailed out must take the form of loans by the central bank, repayable with interest. All this must be perfectly visible to the public. Banks who get themselves into trouble after the next bail out should be required to put up a higher than the current reserve requirement for a number of years.

        There is a whole menu of alternative courses to deal with both rising prices and government deficits. But to recognise these you would have bring the other sectors of our economy into your policy-design: the public sector, the household economy, the ecology.

        But for that, economists must learn what high school students are taught in their first year of physics -- the difference between scalar and vector quantities.

        A scalar is an absolute quantity with no sense of direction. A vector is a quantity with a sense of direction, from the Latin for carrier or traveller. The mass of a potato is a scalar, but when you drop a  potato it falls to the ground because of the vector gravity.

        Economists must be trained to ask what the effects of policies will be when they cross the boundaries of the market and move on to the  ecology, the household economy, and other non-market subsystems of our mixed economy. When that happens, you are in for some surprises. What can be a saving for the private firm when it pollutes the environment, suddenly appears as a threat to human survival when viewed from the ecology. Debt may be a dangerous thing in personal finances, but if you extend that maxim to government, paying off the debt does not make sense if there are still idle workers and resources around. Pay off the government debt? You must ask what are you going to use for money if you indeed paid off the public debt. Sea shells? Our base money today is government debt. There is no other.

        Let me give you an example of the unusupected policy options that would open up if we retrained economists to think in vector terms. For a quarter of a century, inflation and budgetary deficits have been the very pivots of policy-making. However, if you really are concerned about inflation and deficits, balancing one of these against the other in a downward direction should be the point of departure of policy design.
A quarter of a century ago in this sense I proposed the idea of special tax-bonds with an interest rate well below market. To compensate for the lower interest rate, any earnings invested in such bonds and the interest paid on such bonds would be tax-free.

        Even by the initial swap of government revenue for a lesser interest burden the structural price climb would be lessened. Structural price rise is price increase due not to excessive market demand but to the fact that the market makes up a shrinking part of our mixed economy.

        Moreover, insurance features could be incorporated. The tax-free feature would apply only to the original bondholder, so that if the bonds were sold before maturity it would be at a discount because of the lower-than-market interest rate. However, in the event of the death of a breadwinner, extended illness in the family, or lengthy involuntary unemployment they could be made redeemable at par -- i.e. at an effective bonus. equal to the discount the state would forgo. It would thus incorporate a most timely insurance feature.

        In ER of September 1995, I wrote: "Recently somebody sent me a copy of a paper originating in or close to our government. with the title ‘Options for Eliminating Deficits and Reducing Debt.' In it was the statement: "The government could reduce the interest rate it pays on outstanding debt by making such interest tax-free. But what it gains in lower interest rates it would lose in lower revenues." In other words the government would give up a scalar and receive a scalar in return, and the result would be a wash. What is missing is a vector sense that would look into possible advantages of the lower interest rate and lower taxation when the effects crossed the boundaries separating the public sector from other areas of the economy.

        That paper ignores the benefits to the market economy itself in pointing those two key parameters downward instead of upward. Clearly lower taxes and lower interest rates combined would provide an immense stimulus to the private sector. And with both of the parameters turned downward there would be plenty of room for that without fuelling price increases. There is a reason for something so obvious having been overlooked: lowering interest rates does not pass the dominant revenue test -- if interest is your dominant revenue.

        There is an important first step towards making economic policy-making people-friendly once more. The central bank must be brought back to Its original purpose which is still to be found intact in the Bank of Canada Act. A revision of the Bank Act, on the other hand, is necessary to restore the reserve requirement. Internationally, our central bank must press for the repeal of the Risk-free Capital Requirements introduced by the Bank for International Settlements which requires no additional capital for private banks to hold debt of our government must be changed. Until our banks are gotten off the dole and led back to banking, we shall continue to suffer from the Mother Hubbard syndrome: the cupboard will always be stripped bare for speculative high jinx.
And there will always be too many children to know what to do. Under the name of "the non-accelerating inflation rate of unemployment" or NAIRU, the Mother Hubbard fairy tale, passes as pure science amongst economists today.

        For more than a half-century, a well-oiled machine has systematically captured just about every lever of power. It was a catastrophic illusion to believe that this could be countered with a few time-proven policy gimmicks and the sort of catchy slogans readily accessible to the broad public. That might serve to win an election. But electoral successes with such skimpy preparation invariably turn out Pyrrhic victories. Well-intentioned governments find the treasury syphoned to emptiness, and key statistics and the very language twisted like the girders of a bombed building. We must begin by analysing what hit us, and seeking out the vulnerabilities of our formidable foe. Once that is done, then the popularisation will be in place. But the two are not to be confused.

        We do not have a chance unless we match our opponents in the thoroughness of our response.

William Krehm
Editor, Meltdown
Editor, Economic Reform

===============

Copyright (C) 1999 COMER. May be reproduced with proper acknowledgement.

"Economic Reform" is the monthly journal of the Committee on Monetary and Economic Reform (COMER), a Canada-based publishing think-tank.

COMER Publications,Suite 107,245 Carlaw Street,Toronto ON M4M 2S6
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===============
COMER Publications presents a publishing milestone
10 Years, 100 Issues and 1,000,000 Words of monetary and economic reform commentary, now brought together in a definitive collection of selected critical articles from Economic Reform, COMER's monthly journal.
MELTDOWN : money, debt and the wealth of nations : how zero inflation policy and deregulation have turned the world economy into a global casino : as documented in the first decade of Economic Reform

(The John Hotson memorial series) Includes bibliographical references and index. ISBN 0-9680681-2-X, 400 pages, 6X9 SC

"An important critique of 10 years of economic policy blundering that led to today's unsustainable global casino -- with many key proposals for reform and a more sensible, equitable and financial architecture for our common future."
Hazel Henderson, St. Augustine, FL, author, Building a Win-Win World

• To order a copy of MELTDOWN, send $25 + $4 postage and handling
($29) to:

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Qualified individuals (academic, media, etc.) may request a complimentary copy by writing the request on letterhead, and please enclose $5 to help defray shipping costs.
 Please contact COMER for orders greater than 5 copies.

What's Next on the road to a Real Social Union - We need public Consultations.
     On January 29th John Sewell joined together with a loosely affiliated group of citizens, Canadians for a Real Social Union, came together to state among other things:
We want a new process with the express objectives of producing the following outcomes:
1)  An end to poverty and hunger by income support programs and job strategies which each year reduce the number of people living in dire circumstances;
2)  Strong public health programs and the accessibility by everyone, regardless of income, to high quality health care in a timely fashion;
3)  Good housing that all households can reasonably afford;
4)  High quality and affordable public educational opportunities for everyone;
5)  High quality child care across Canada for all children;
6)  High quality immigrant and settlement programs and services;
7)  An inclusive society which enhances equity and equality, and assures a
rich cultural life;
8)  An enhanced environment, and strong environmental protections.

     Governments at all levels should commit themselves to work together to achieve these goals, and to take action to improve the social conditions year by year. The process employed should be open, transparent, inclusive, and timely. It should be led by government, and include forums for wide-ranging public discussion of the creation of a strong society and how governments can co-operate to achieve these objectives.
     On February 4th - In secrecy - the Deal was struck and signed – without municipalities or citizens knowing what was in store. In fact we know the Federation of Canadian Municipalities repeatedly asked to be included in the talks and were not even acknowledged. Since then we have seen and you have heard a range of opinions on the issue including one take which may mean this is good for some. Good or bad the fact remains the process and the content will not result in the clear outcomes we articulated as a group. I believe there are some clear points to consider here and that there is one path for the municipality to take - the points are:

1. The agreement is based on a false premise. The document consistently talks about the governments involved in social programs as being only the federal and provincial governments. But in Ontario (and in other provinces as well), municipal governments are increasingly bearing the financial burden of social programs. Yet municipalities are no where mentioned in the agreement, and they  get none of the so-called benefits: funding predictability; prior notice of new  programs; dispute resolution; joint planning; collaboration; notice and  consultation.
2. The agreement forgets that most Canadians live in cities. The agreement talks about the need to ensure good programs which support mobility – but with more and more social program under municipal financial control, programs will vary from municipality to  municipality. The example of ambulance service in Ontario is relevant: it has  been downloaded onto municipalities, and municipalities without funds will  provide very poor service no matter what the province demands, putting a lie to  mobility in respect of those who live in cities. Neither the provincial nor federal government can ensure quality services which they refuse to fund.
3. The agreement is hypocritical. Section 3 of the agreement talks about the  importance of public accountability, transparency, and involvement - yet this  agreement was worked out behind closed doors, deliberately refusing to provide  information to those who asked, and refusing to allow the participation of  municipalities.
4. The agreement refuses to ensure that there are or will be strong social programs for Canadians. No where does the agreement state that the objective is to ensure strong social programs for Canadians - instead, there are  a number of mealy-mouthed phrases in Section 1. As if to drive the point home,  the agreement talks not about measuring impacts of programs before they are  ended, but measuring them afterwards, when it is too late.
5. Federal initiatives are held hostage to the provinces. Section 5 requires the federal government to  have 50 per cent of the provinces on-side before it can undertake a social  program involving intergovernmental transfers. This is yet another road-block to Canadians receiving social programs which they might think they are voting for  when they vote in federal elections.

What should happen next?
a) The federal government must undertake that this agreement will not be considered final until there has been public discussion and public feedback which assures a reasonably independent observer  that the public is in support of this agreement.
b) The federal government must undertake a public process of information and discussion around this agreement over a  period no shorter than 3 months. This must permit opportunities for public input, and must include the Federation of Canadian Municipalities, the Canadian  Council on Social Development, and other relevant social bodies.
c) Each province which supports this agreement must also agree to be part of the public discussion process.

     On February 11th a delegation for Canadians for a Real Social Union asked Toronto City Council - Neighbourhoods Committee to pass a motion to begin consultations on the impact of the New Social Union Deal. The motion was passed unanimously. To get involved contact your Federal MP or Provincial MPP and ask them what they are doing to engage citizens in discussing the future of  the social structure in this country.
=========

But none of this is actually true.

 The truth is that poor people -- vast majorities in most countries of the world -- need to eat every day. Policies that guarantee that they can do so, and with steadily improving diets and housing and health and other material conditions of life over long time spans, are good policies. Policies that foster instability directly or indirectly, that prevent poor people from eating in the name of efficiency or liberalism or even in the name of freedom, are not good policies. And it is possible to distinguish policies that meet this minimum standard from policies that do not.

 The push for competition, deregulation, privatization and open capital markets has actually undermined economic prospects for many millions of the world's poorest people. It is therefore not merely a naive and misguided crusade. To the extent that it undermines the stable provision of daily bread, it is actively dangerous to the safety and stability of the world, including to ourselves. The greatest single danger right now is in Russia, a catastrophic example of the failure of free market doctrine. But serious dangers have also emerged in Asia and Latin America and they are not going to go away soon.

 There is, in short, a crisis of the Washington Consensus.

The crisis of the Washington Consensus is visible to everybody. But not everybody is willing to admit it. Indeed, as bad policies produced policy failures, those committed to the policies developed a defense mechanism. This is the argument that treats every unwelcome case as an unfortunate exception. Mexico was an exception -- there was a revolt in Chiapas, an assassination in Tijuana. Then Korea, Thailand, Indonesia became exceptions: corruption, crony capitalism on an unimaginably massive scale, was discovered, but after the crisis hit. And then there came the Russian exception. In Russia, we are told, Dostoyevskian criminality welled up from the corpse of Soviet communism to overcome the efficiencies and incentives of free markets.

But when the exceptions outnumber the examples, there must be trouble with the rules. Where are the continuing success stories of liberalization, privatization, deregulation, sound money and balanced budgets? Where are the emerging markets that have emerged, the developing countries that have developed, the transition economies that have truly completed a successful and happy transition? Look closely. Look hard. They do not exist.

 In each of the supposed exceptions Russia, Korea, Mexico, and also Brazil state-directed development programs have been liberalized, privatized, deregulated. But then, capital inflows led to currency overvaluation, making imports cheap but exports uncompetitive. As early promises of "transformation" proved unrealistic, the investor mood soured. A flight to quality began, usually following moves to raise interest rates in the "quality" countries -- notably the United States in 1994 and in early 1997. A very small move in U.S. interest rates in March 1997 precipitated the outflows of capital from Asia that led to the Thai crisis. I have elsewhere called this the "Butterfly Effect," with Alan Greenspan in the role of the butterfly.

 The Russian case is especially sad and dramatic. In 1917 the Bolshevik revolution promised a war-weary Russian people liberation and deliverance from oppression. It took them seventy years to forget the essential lesson of that experience, which is that there are no easy, sudden, miraculous transitions. In 1992, the advocates of shock therapy followed the Bolshevik path, against the good sense of much of the Russian political order, by Bolshevik means. This was the true meaning of Yeltsin's 1993 military assault on the Russian parliament, an act of violence which we in the West tolerated, to our shame, in the name "economic reform."

 Privatization and deregulation in Russia did not create efficient and competitive markets, but instead large and pernicious private monopolists, the oligarchs and the mafiosi, with control over competing industrial empires and the news media. And these empires sponsored their own banks, which were not banks at all but rather simply speculative pools, serving none of the essential functions of commercial banks. Meanwhile, the state followed a rigid policy of limiting expenditures, so that even wages and pension obligations duly incurred were not paid -- as if the United States government were to refuse to pay Social Security checks because of a budget deficit! The private sector literally ran out of money. The payments system ceased to function; tax collection became impossible because there was nothing to tax. The state financed itself through a pyramid scheme of short-term debts, the GKO market, which collapsed as pyramids must on August 17th, 1998. This was the end of free-market radicalism in Russia -- and still, the Washington Consensus holds that Russia must "stay the course" on "economic reform."

Throughout Asia in the 1990s, stable industrial growth gave way to go-go expansions based heavily on real-estate speculation and commercial office development. Many more office towers went up, in Bangkok, Djakarta, Hong Kong and Kuala Lumpur, than could reasonably be put to use. Once finished, these towers do not go away; they stay empty but available, and so remain a drug on the market, inhibiting new construction. Recovery from the crash of such bubbles is a slow process. It took five years or longer in Texas of the mid 1980s.

 As for Brazil, through the early fall of 1998 it was said that the IMF would restore confidence and keep the Brazilian real afloat. But the real has since devalued and Brazil is heading for a deep recession. The problem here does not originate with Brazil, and cannot be resolved by any actions the Brazilians alone might take. It lies, rather, in the international capital markets. Investors with exposure in Asia, and with losses in Russia, must reduce their lending to other large borrowers, irrespective of conditions in those countries. It is this imperative that is Brazil's problem today.

 Are there alternatives? Yes. The grim history I've just outlined is not uniform. Over the past half-century, successful and prolonged periods of strong global development have always occurred in countries with strong governments, mixed economic structures and weakly developed capital markets. This was the case of Europe and Japan following World War Two, of Korea and Taiwan in the 80s and 90s, of China after 1979. These cases, and not the free market liberal examples -- such as, say, Argentina after the mid-1970s or Mexico after 1986 or the Philippines or Bolivia -- are the success stories of global economic development in our time.

 If one examines Korea, for instance, one finds that the great period of economic development was, indeed, a time of repressive crony capitalism. After 1975, the Korean government took note of the fate of South Vietnam, drew its own conclusions about the depth of American commitment, and embarked on a program of heavy and chemical industrialization that emphasized dual use technologies: the first major product of Hyundai Heavy Industries, for example, was a knock-off of the M-60 tank.

The Korean industrialization policy was not, in any static sense, efficient. No market would have chosen this course of action. The major players in the Korean economy-- the state, the banks, the conglomerates known as chaebols -- were yoked together in pursuit of their goals. Workers and their wage demands were repressed. And the initial search for markets was by no means entirely successful. There wasn't a big demand for those tanks, and so Hyundai decided to try building passenger cars, instead.

And yet, when one adds up the balance sheet of the Korean model, can anyone seriously argue that the country would be richer today if it had done nothing in 1975? That it would be more middle class, or more democratic?

It is true that Korea experienced the first harsh blows of the Asian financial crisis. But why? By 1997, the industrial policy was a thing of the distant past. Korean banks had become deregulated in 1992. What they did was to diversify -- supporting vast expansion and industrial diversification schemes of the chaebol -- Samsung's adventure into motor cars, for example -- and lending to such places as Indonesia, where the Koreans evidently bought paper recommended to them by their American counterparts.. The crash of Indonesia spread to Korea by these financial channels. It was not a crisis of crony capitalism, but of crony banking -- deregulated and globalized.

 One can multiply cases, but let us look at just one other, that of China.

 China is a country with a fifty-year tradition of one-party government. For thirty of those years, it was a case study in regimentation, ideology, and economic failure. At one point, there occurred an entirely avoidable, catastrophic famine during which twenty or thirty million people perished. In the first years of the Great Proletarian Cultural Revolution, village rations amounted to a pound of rice per day.

Beginning in 1979, however, China embarked on reforms that changed the face of the country. These began with the most massive agricultural reform in human history, reforms which effectively ended food poverty in China in five years. After that, policies that welcomed long-term direct investment, that fostered township and village enterprises, joint ventures and private enterprises, put into place a vast and continuing improvement in human living standards. Over twenty years, average living standards more than quadrupled; indeed growth has been so rapid that many people can perceive the improvement in their standard of living from month to month.

 China's case demonstrates the potential effectiveness of sustained development policies -- of policies that emphasize the priority of steady improvement over long periods of time. Unlike Russia, China made the mistake of the Great Leap Forward only once. And it never liberalized its capital markets or its capital account, for fear that such actions would prove a fatal lure, unleashing a cycle of boom and bust that a poor nation cannot tolerate for long.

 China is today no democracy. It is not politically free. But one must also acknowledge that the Chinese government has delivered on the essential economic demands of the Chinese people, namely food and housing, and that an alternative regime which did not deliver on these needs would not have been able to deliver internal peace, democracy or human rights either.

 So, what can the United States do now? To begin with we can, recognize that globalized finance makes the Federal Reserve central banker to much of the developing world. Interest rate cuts last fall had an important stabilizing effect on global markets. But this effect is temporary; and the Fed's powers are limited. After a cut, another one is eventually required; and the cut from one to one-half percent lacks the force of the reduction from six percent to four. There is a strong case for lower interest rates, but we must also remember that that the long term arrives when such short term policies run out of steam.

 Then there is fiscal policy. If it is a good idea for Japan to run a deficit to fight the global recession, why is it wise for the United States to be running a surplus that vastly offsets the deficit in Japan? It isn't wise. The United States should frankly expand its own economy using all the tools available for this purpose.

 Then there is the matter of what we preach to the world and the policies we support. If it is a good idea for the government of the United States to grow in line with our economy, then it is also a good idea for the governments of other countries to grow as their economies do. Global development policy should be geared toward strengthening that capacity, not crippling it.

 Every functional private economy has, and needs, a core of state, regional and municipal enterprises and distribution channels to assure food and basic necessities to low-income populations. Such systems stabilize the market institutions, which work better for people with higher incomes. They help prevent criminal monopolization of critical distribution networks by setting up an accountable alternative. International assistance should seek to strengthen these public networks where they exist, and to build them where they do not. Efforts to do just this in Russia today, under the present government, should be supported and not opposed.

There is an obvious conflict between pro-growth policies and "investor confidence." Investors like to be repaid in the short run. But given that conflict, it is a fool's bargain to place investor confidence above the pursuit of development. Strong national governments have a sovereign right to regulate capital flows and banks operating on their soil -- as much right as any nation has to control the flow of people across its national frontiers, and to regulate their activities at home. A Tobin Tax on foreign exchange hould be enacted here, not only to slow speculation in the United States, but also to signal our acceptance of this principle for other countries, for whom different mechanisms of capital control may be more suitable in different cases.

 Beyond this, a major reconstruction of world financial practices, aimed at restoring stability and strengthening the regulatory and planning capacities of national governments, is in order. The IMF needs new leadership, not tied to recent dogmas. But the IMF is also too small, and too thinly spread, to be useful in helping countries with the design and implementation of effective national development schemes. Regional financial institutions, such as suggested for Asia by Japanese Finance Minister Eisuke Sakakibara, are therefore also needed and U.S. opposition to them should be dropped.

 Most of all, and in summary, we must give up illusions. The neoliberal experiment, is a failure. And it is a failure not because of unforeseeable events, but because it was and is systematically and fundamentally flawed. We need many changes from this naive and doomed vision of an ungoverned world order. We need large changes, and the need is great while time, I believe, is short. We must bring the Reagan era to a final end. We must return to development policies for the people whose needs matter most in the large scheme of things, namely the millions of hard-working people in poor countries who need to eat every day.
 
 

James K. Galbraith is the author of Created Unequal: The Crisis in American Pay. He is working on a new book on global inequality.

Copyright 1999 by the Foundation for the Study of Independent Social Ideas, Inc. Readers may redistribute this article to other individuals for noncommercial use, provided that the text, all HTML codes, and this notice remain intact and unaltered in any way. This article may not be resold, reprinted, or redistributed for compensation of any kind without prior written permission from the author. If you have any questions about permissions, please contact dissent@igc.apc.org, or write to Dissent, 521 Fifth Avenue, Suite 1700, New York, NY 10017.

Never was a government caught so red-handed in cooking its books. The
sixties were a period when the nation was catching up with public investment after a decade of depression and five years of war. New technologies were brought in demanding costly infrastructures and vastly better educated humans. Ottawa, however, was treating those capital investments in a way that would land a private party in jail. In the words of the Canada Year Book (1988), page 22-6: "Fixed capital assets, such as government buildings and public works, are charged to budgetary expenditures at the time of acquisition or construction and are shown on the statement of assets and liabilities at a nominal value of $1.00."

          For over three decades, in the successive Canada Year Books within our ready reach, that frank and open statement appeared without a single word changed.

          Even the attempt to cover the costs of long-term public investments in a single year loaded the price of marketed goods with an excessive amount of taxation. There was a simple way of calculating that and deducting it from the real "inflation" that reflected too much demand and not enough goods on the market.1 But any suggestion of making adjustments to provide statistics that reflected the true reality was resisted. To those who were preparing to undo the new social structures, such anti-accountancy was too useful to be surrendered. The misleading accountancy was used to pump up the "war against inflation." One by one, all other methods that really worked for that purpose in the past were suppressed. In this way an enormous portion of the national product was shifted from the productive population to financial institutions.

          Rather than using our central bank to hold a substantial amount of federal debt (it had approached 25% in the mid-seventies), the figure was reduced year after year to the 4% where it stands today. What difference does that make? Plenty. When the Bank of Canada holds federal debt the interest paid on it finds its way back to the government as dividends—for since 1938 the government has been the sole shareholder of the central bank. When the chartered banks hold the same debt, the interest stays with them. The Bank Act was amended and the Risk-Based Capital Guidelines of the Bank for International Settlements was written to allow the banks to increase their holdings of federal debt by some $60 billion without putting up any cash of their own.

          By such devices the banks were helped out of their speculative losses of the eighties—at the expense of the public treasury. That initiated the massive slashing of public services. The price of everything now comes burdened with a grotesque hump of interest.

          To show how different the treatment of government accountancy and that allowed our banks, let us point out that while government capital assets were valued at $1 on its books, the banks portfolios are entered on their books at their historic value, that is at their original purchase price. That includes Indonesian bonds and interests in Latin American banks.

          When the interest load becomes unsustainable, the currencies and the entire economies cave in. Only then did interest rates come down for a period. But that makes it possible for large speculators to move in and pick up distressed assets for a song. Stock market speculators have themselves a field day.

          As recently as 1995, we noticed that the above-quoted passage in the Canada Year Book that for decades had so clearly described the government's investment accountancy had disappeared. We contacted Statistics Canada and asked when it had been taken out and why. To this day we have received no answer. And now Banquo's ghost, so thoroughly disposed of, has made a chilling appearance at the banquet table.

          Conrad Black's National Post made an inexpensive scoop in reporting that an agreement was reached between the Auditor-General and the Finance Department to introduce capital budgeting (accrual accountancy) into its books over a two year period. The Auditor-General, Denis Desautels, had for the past couple of years refused an unconditional approval of the government accounts because of that and other problems. For that agreement the Auditor-General paid a staggering price. In the Post article (by Kathryn May 20/07) Desautels is quoted incredibly saying: "the capitalisation of assets was critical to departments' ‘management discipline.' For example, the manager of a government laboratory never had to consider the cost of the space the lab occupied or the equipment used when it determines the price-tag of its programs.' Mr. Desautels argues these figures become more critical with the government's push to recover more of the costs from user fees."

          In short "capital budgeting" has been brought in to justify ‘the fees the government charges.' It reflects the invasion of market ideology into the public sector. But not a word on the effect of the $1 value placed on all the government's buildings and equipments in grossly exaggerating the government deficit. And that bogus deficit figure was the pretext for dismantling vital public services.

          That distorted deficit figure served as well to justify sky-high interest rates. (They reached 20% and more in the early eighties.) The deficit was supposed to have left the government with no alternative to bankrupting firms and individuals. They broke up families and brought on suicides galore. And now by the government's own admission it turns out to have been an illusion created by bum accountancy. You might imagine that our government might be suffering pangs of conscience. Not a hint of that.

          And rather than make amends, capital budgeting seems to have been introduced primarily to justify tax cuts so badly needed to keep the stock market bubble from collapsing. For the name of the game is after-tax profits. The increase in the bottom line achieved by a tax cut is at once extrapolated into the future and then discounted for present value at the prevailing interest rate. But a lower government deficit achieved by capital budgeting has the effect of bringing down the interest rates employed for discounting future earnings for their present value. On top of that the higher disposable income resulting from cuts in personal taxes means that more money enters the stock market on the buying side and thus stock market indexes are pushed up.

          These are the sundry blessings for the ultra-affluent that can be expect from the belated introduction of capital budgeting. But on one condition: that the monumental scam represented by their failure to do so years ago is kept in the dark.

          That is why the two established broadsheet dailies in Toronto—The Globe and Mail and the Star have still not breathed a word about the introduction of accrual accounting in Ottawa.

          The United States achieved a similar result as early as 1995. In that year the Bureau of Economic Analysis quietly brought in accrual accountancy insofar as it recognised government saving, and carried the revision of the earlier figures back for several years. What their canny President and his team were aiming at was a statistic that would reflect a budget in better balance to bring down interest rates and eventually produce a surplus. The details that led to that statistic were kept secret in order not to arouse the bark and bite of the formidable American right. Thus it came to pass that Economic Reform and our Pennsylvania correspondent who brought the ploy to our attention were to the best of our knowledge the only ones who gave any publicity to this historic partial reswitching of human destiny.2

          But since the whole exercise is focussed not on letting in light on the economy but on prolonging the speculative bubble, there is little solace in these half-measures.

          That is why Economic Reform and COMER will not let matters rest there. We need a Truth Watch that will scrutinise every move of our government in the semi-shadows. We invite other concerned organisations to join us in setting up such oversight of what our government is up to.

          But are such matters as capital accountancy not too "esoteric" for the average person? Nonsense. Few people manage to buy a home without taking on a mortgage. Capital budgeting is neither more nor less complicated than the mathematics of mortgages. The alleged complexity of issues that really count is a fiction created by our opponents for a strategic purpose.

1 William Krehm A Power Unto Itself—The Bank of Canada, p. 73, Stoddart, 1993.
2 Meltdown, edited by William Krehm, COMER Publications, 1999, pp. 224-5.

William Krehm Chairman, COMER Editor-Publisher, Economic Reform mailto:wkrehm@ibm.net

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Copyright (C) 1999 COMER. May be reproduced with proper acknowledgement.

"Economic Reform" is the monthly journal of the Committee on Monetary and Economic Reform (COMER), a Canada-based publishing think-tank. Annual subscription, 12 issues, is $30.

COMER Publications Suite 107, 245 Carlaw Avenue, Toronto ON M4M 2S6 - Telephone (416) 466-2642 Fax 466-5827
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

The TD Goes to the Altar Again By William Krehm

Just eight months after its merger with the CIBC was blocked by the federal government, the TD Bank is taken unto itself another bride. A gorgeous gal with no lack of suitors and for whom the bride money is anything but light. It is Canada Trust (CT), a division of Imasco that the British-American Tobacco (BAT) corporation has acquired in its bid to obtain complete control of Imasco's tobacco operations. During three months of what are described as "brutal negotiation between the two tobacco holding companies" in an appropriately smoke-filled boardroom, the mating of BAT and Imasco was hammered out. And to help pay for it, BAT -- subject to government approval -- has sold Canada Trust to the TD Bank for top dollar at the peak of the stock market -- $67 a share -- compared to the $47 before the deal was announced.

          The premium price has been justified by the fact that CT was the last of the large trust companies not absorbed by banks. Trust companies in Canada are roughly the equivalent of the Savings and Loans in the US. Originally established to allow small homeowners to finance their homes, they sell shares rather than take deposits and thus are not required to insure their quasi-depositors. These do build up equity by putting money into the trust, which becomes a source of mortgages to them or others. Their main purpose in a distant past was to provide mortgages when banks could not lend on mortgage security and financing of modest homes was hard to obtain. With deregulation of the finance industry these boundaries have grown fainter. Today banks are by far the main players in the mortgage field. Bailed out of their past speculative orgies in the early nineties, with an ongoing entitlement amounting to well over five billion dollars a year, banks haven't the time of the day for small customers.1

          The same TD Bank just a couple of years ago was promising clients the payment of we don't remember how many dollars if they had to wait in line for more than five minutes to see a teller. That ad, however, was pulled in a hurry, and spending 15 or twenty minutes in a TD lineup is not an uncommon occurrence. Our banks are off on major expeditions in countries like Venezuela, Mexico, the Argentine, China where game comes big and the dice are constantly rolled, even if not infrequently they do fall off the table.

          Meanwhile credit unions and what trust companies remain have taken advantage of this departure of the banks to grander climes. Many have made a point of catering to the needs of the modest borrower not content to do his financing on the banks' credit cards at twice prime or more. Most spectacular of these, and the sole major trust company still not taken over by a bank, was CT. Well run since 1993 by a highly talented ex-civil servant, Edmund Clark, it took full advantage of the public resentment against the banks to build its retail business. Indeed, it is for the fruits of this policy that TD is paying a price that is causing Bay St. to arch its eyebrows.

          To raise the money to cover that price TD has announced that about 11% of the combined staff of both organisations will be cut. The trouble is that many of the clients that CT attracted because of the human touch that Clark emphasised may take French leave of CT as restructured by TD. There will certainly be a dearth of money to lavish on the human touch. Instead it will be left to ATMs to assess the "character, character, character" that bankers used to claim was their main criterion in granting loans. The writedown for the layoffs will amount to $475 million. On the other hand it will not be able to stand too much CT customer loss. For this will not be a banner year for the TD if Internet stocks continue their plunge. The TD is most deeply into stock market brokeraging amongst our banks.

          There is a lot of human drama packed into this takeover. Clark is highly regarded for his talent and connections among the Ottawa bureaucrats. As a high-placed civil servant in Finance and Energy, Mines and Resources under Trudeau, he was prominent in drafting the National Energy Program so loathed by Western oil and gas interests. When Mulroney became PM, firing Clark was one of his first acts, though as a civil servant he was merely carrying out the instructions of his government. The deputy minister over him, the Toronto lawyer, Mickey Cohen, on the other hand was promoted by the same Mulroney "left and right," but Mulroney always a master of show biz probably couldn't resist the "Red Ed" moniker that the oil and gas folk had pinned on Clark -- because he had chosen socialist policy in Tanzania as the subject for his doctorate thesis at Harvard. It turned out that Mulroney did Clark a great favour. On the strength of his performance in settling the affairs of a hopelessly broke small trust company, he was hired to head CT and in a few years had become a man of great wealth. His secret weapon was by attracting bank clients by treating them with a bit of ostentatious care.

          The timing could not have been better from the standpoint of our business reporters. With Matthew Barrett retired from the chief job at the Bank of Montreal and from a colourful if hapless marriage and now appointed to head Barclay's bank -- the third largest in Britain -- Canada's banking world threatened to relapse into its traditional dullness. Clark, a scholarly man, unstultified by a Harvard economics degree, does not make the splash with his new-found wealth that Barrett did. But then the background, too, has changed. If he succeeds to the head of TD eventually as many are predicting, he is likely to have to face the trials that will dwarf those of the National Energy Policy when energy prices tumbled.

          However, given the crossroad at which the world economy has arrived, more Canadians than those employed in banking have a vast stake in whether the proposed merger is to be allowed. The concern of the country goes far beyond many people are to be laid off. Since no business and few consumers can make do without access to financing, to centre the discussion on the TD payroll is an evasion. It remains so even when you throw in the circumstance that the acquisition of CT from BAT repatriates an important financial institution.

          But that is just what is being peddled in the press. It is amazing how slow the Canadian Bankers Association is to learn that the Canadian public, though ill-informed, cannot be written off as morons.

          Thus in The Globe & Mail (9/08) Mark MacKinnon tosses around the numbers ranking Canada's five big banks on a world scale for size. "The $8 billion [CT] deal would push it up 23 spots to 46th place, nestling it snugly between Japan's Tokai Bank and France's Paribas." "According to a recent ranking, Canada's five biggest banks were the 49th, 52rd, 54th, and 69th internationally, when measured by 1998 shareholder equity. Fourteen years earlier, when Canada's banks peaked in the ranking, Royal Bank was the 22nd largest bank in the world."

          But such comparisons are next to meaningless. As COMER was amongst the earliest to point out, to counter the banks' silly campaign to get federal approval for the two mergers proposed a couple of years ago: Several of the largest banks in the world -- Japanese -- had lost most, all, or more than all of their total capital.

          Even apart from that the international ratings of our banks by size is meaningless. In most cases our banks' investments appear on their books at their historic costs rather than at market values. And the financial geniuses at the head of our banks who loaned heavily to the Reichmans and Robert Campeau, when some of them had their head offices in their very buildings but were clueless about their financial troubles, have fared no better as carefree tourists sinking countless hundreds of millions of dollars into Latin American, and East Asian banks.

          What business is this of lowly Canadians? Plenty. There is an unwritten law that when a bank is too large to fail, it is not allowed to fail. And Canada's banks were large enough to qualify under this invisible clause to have been bailed out by our government on the average more frequently than once a decade over the past thirty years. Since deregulation has proceeded apace over this period, allowing them to merge further will merely increase both the frequency in such bailouts.

          Then again, when the banks and the journalists at their beck produce such figures, they ignore the fact that such international ratings based on stockholders' equity depend on the exchange value of the Canadian dollar. Are the banks suggesting that our government guarantee them against the ups and down of our floating dollar?

          For our government and the public to reach a serious decision on the proposed merger of the TD and CT, there must be a frank disclosure of the previous bailouts of our banks and their immense cost not only in tax dollars and planned recessions, but in the covert reshaping of our financial system to please the banks. Because the terms of the bailout would not stand up under the light of day, the government became in effect accomplices of the banks. The banks were able to dictate the terms of the bailout. That is how we arrived at where we are today, where interest rates -- the revenue of a privileged potentially parasitic group -- was proclaimed the only "blunt tool" for controlling inflation.

          The ceilings on the interest deposit-taking institutions could pay on their deposits or charge their borrowers, were removed. The restrictions on the investments in which the banks can invest other people's funds, borrowed or deposited with them, were done away. The banks were able to increase their holdings of government bonds by some $60 billion dollars without putting up a penny of their own money, and to provide the elbow-room for that the central bank reduced its holdings of government bonds even in absolute terms, rather than just a percentage of the government's borrowings. The interest paid on government debt held by the Bank of Canada reverts substantially as dividends to its single shareholder, the Government of Canada. On the other hand, commercial banks keep the interest paid on the debt they hold. Thus the end result of the bailout was that the banks piped directly into the public treasury.

          Even the financial press is now concerned with the effect on the stock market of the current meltdown of Internet stocks and the glut of Initial Public Offerings. The drop in the quotes of bank shares in recent months suggest that they will be back with their begging bowls at the government's door. This is no time to rush ahead approving a further merger that will increase the vulnerability of the bank most closely associated with the stock market. Would the TD approve a major loan to a client for the financing of a takeover at top market price at the present juncture? (True, the government is not lending the TD the money for the buyout, but they are on the hook for the trouble TD may get into.) If the answer is yes, that is a further reason for the government not authorising the purchase.

1 The great Yiddish storyteller Sholem Aleichem, has a tale that illustrates the problem with the TD-CT deal.           The Jews of the town of Chelm in Poland had a reputation among other communities of not being bright. One of these praising the size and brilliance of the moon in his hometown, offered to sell the Chelm Jews their moon. And he quoted a very attractive price.           "But how will you deliver it?" the Chelm citizen asked.           "No problem. In a barrel of water. We will even put it on your cart at no extra charge."           The deal went through. The Chelmer was invited to check the beautiful reflection of the purchased moon in the barrel of water. He was allowed to personally witness it was not removed before the lid was nailed to the barrel.           However, despite such safeguards when the Chelm folks opened the barrel the moon was no longer there.           There is a moral to this story, otherwise we would not have wasted our readers' time telling it.           Here it is: The TD could have achieved the same and even a better result without paying a cent to buy CT, and without need to get Ottawa's approval, or pay those fancy spin doctors' who must be running up some very impressive billings. How?           Merely by increasing their tellers and branch managers, sorting out the creditworthy clients, and serving them even to the standards of a decade ago.

William Krehm Chairman, COMER Editor-Publisher, Economic Reform
mailto:wkrehm@ibm.net

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Copyright (C) 1999 COMER. May be reproduced with proper acknowledgement.

"Economic Reform" is the monthly journal of the Committee on Monetary
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