We also need to rethink our banking and financial system. I've argued this elsewhere[1] and I'll skip the details here but, in a nutshell, we need major revisions to the whole system.
One problem is that most of our banks have national charters, which allow them to move deposits from all parts of Canada to a few central offices.
The United States became the wealthiest country in the world with state banks that, until 1956, were not allowed to operate across state lines. When a farmer in Boondock Iowa put his money into the Boondock State Bank the bank had to use that money in the state of Iowa. Because budding businesses in every state could find the capital they needed, the United States has major industries in almost every state.
Because most Canadian banks have federal charters they can move money around the country. Like farmers in Boondock the people of Elk's Elbow Saskatchewan keep their savings in the local bank, but the local bank in Elk's Elbow is a branch of the Bank of Halifax.
Because the bank is national it can move money around and because the branch in Elk's Elbow is small, the local manager has not much authority. When a businessman in Elk's Elbow needs a big loan, the local branch can't help him.
To get a big loan a businessman from Elk's Elbow has to go to the bank's head office in Toronto but the vice president there doesn't have to take a chance on some small business way off in Saskatchewan. The bank can use the Elk's Elbow deposits in Toronto and if someone in Elk's Elbow wants to start a business, he can come to Toronto to do it.
The fact that the best investment might be in Elk's Elbow is irrelevant. The bank's officers are in Toronto and they find it hard to conceive of any business other than logging, mining or oil, that could prosper outside a big city.
Because big city businessmen have access to the banks they can also take over businesses in outlying areas. The Elk's Elbow Eclectic Eggbeater Co. is a good business but, because it's located in Elk's Elbow, it can't borrow the money it needs to expand.
Enter Torontosaurus Corp, a conglomerate that already owes the Bank of Halifax several hundred million dollars. Torontosaurus knows that EEEE is a good company and -- partly because it's already in hock to the bank -- it can borrow enough money to buy it and to finance the expansion.
But Torontosaurus has no commitment to Elk's Elbow and it may build the new EEEE factory in the third-world country of Whobblegock, where skilled tradesmen earn the equivalent of one Canadian dollar a day. If the people of Elk's Elbow had been able to keep their money in a local bank they could also have kept the town's leading industry, but national banks tend to channel everything to national centers.
The Canadian system of zero reserve banking is also a problem. All banks can lend more money than they actually have but in most countries they must have some money of their own. The amount an American bank can loan, for example, is limited by the amount it has on deposit in a Federal Reserve Bank.
Canadian banks used to keep reserves in the Bank of Canada but since July of 1994 Canada has used a "zero reserve system" under which banks don't have to keep an actual reserve. They have to maintain accounts in the Bank of Canada but they don't have to keep any money in those accounts. The theory is that they deposit when they can and withdraw when they need to but, rather than keep money in the bank, they just have to maintain an average balance of zero in the account.[2] England and Mexico also have zero-reserve systems.
If they have a reasonable cash flow, in other words, they don't have to have any money at all. Banks have always been able to "create" money but in a reserve system they must have seed capital of their own to make it from. In a zero reserve system, they can make money from thin air.
And they do make billions of dollars for wheeler dealers who buy, sell and merge companies with reckless abandon.
A billion-dollar loan might not upset Canada's national economy but we are not dealing with a single loan. As wheeler-dealers do their thing, Canadian banks loan several billions of dollars a year.[3]
SAY'S LAW
That's a problem because of Say's Law. In the early 19th-century French economist Jean-Baptiste Say realized that if money is a medium of exchange, then all the money in the world should be just enough to buy all the goods in the world. It will never work out exactly on a world scale, of course, but we can see the principle on a local scale.
If a hypothetical closed community has 100 units of money and 100 units of goods, the average price of goods will be one unit of money per unit of goods. It won't go higher because if the supply of money runs short while vendors still have goods to sell they will reduce prices in order to sell all they have. It won't go lower because if the price drops buyers will still have lots of money while there are few goods left to buy, and prices will rise.
If I borrow 50 units of money from a bank the bank will create the money and we will have 150 units of money in the community. If I use the new money to create 50 units of new goods we will have 150 units of money and 150 units of goods. The community will be richer but the cost of living will remain at one unit of money for one unit of goods.
But suppose I use the 50 units of new money to buy 50 units of goods that already exist. Now we have 150 units of money but still only 100 units of goods, and the average cost of one unit of goods will rise to one-and-half units of money. By using new money to buy existing goods, I create inflation.
Conventional wisdom tells us that because bank loans and credit sales are balanced by debts and because in theory they will eventually be paid off in real money, they make no difference to the economy.
That's true, up to a point. There is obviously no problem if I buy a used car or a TV set on credit, but what if I borrow a billion dollars?
The money is new and even if I will repay it some day, it will still exist after it is repaid. The long-term effect of a big loan will depend on what I do with the money.
If I use a billion dollars of new money to build a factory or a block of apartment houses or a fleet of fishing boats I create new wealth. The new money will soon be balanced by new goods and there may be a slight bump in the economy but the balance of goods and money will be maintained.
But suppose I use a billion new dollars to buy apartment houses or a factory or a fleet of fishing boats that someone else built ten years ago? Now we have an extra billion dollars in circulation, but no new wealth has been produced.
The balance between wealth and money has changed and all money will lose enough value, through inflation, to restore it. There is no conceptual difference between using a billion dollars of new money to buy an asset that already exists and printing a billion dollars to pay our debts.
As existing business are bought, sold and merged our banks make dozens of billion-dollar loans every year, and the annual flood of new money creates inflation -- which makes it easy for borrowers to pay their loans off. Then they can borrow another billion to buy another established business and start another round of inflation.
Because wheeler-dealers tend to buy established companies rather than start new ones, they seldom create any real wealth to balance the new money they pour into the system. Because their manipulations devalue all our money, the wealth they gain creates poverty for everyone else.
If I borrow to build something new the bank advances money on my production and the ultimate result will be more wealth to be shared by all. When I borrow to buy existing property the bank agrees to share everybody else's production with me. That's not fair, because the bank does not own the production it offers to share.
Now our banks are taking the next step. Having grown rich by funneling the savings of small town Canadians into big cities and with the leverage of a zero-reserve system, they are moving into the global market to lend Canadian money to foreign businessmen who will use it to open mines and build factories to put Canadians out of work and to buy Canadian assets that Canadians can no longer afford.
That bothers me. Global Greed Inc. is based in the Gobblewobble Islands and owned by a billionaire who lives in Bongolia, and when it buys the Canadian Bubble Manufacturing Company we think of it as foreign investment. But what if Global Greed finances the deal with Canadian money created by and borrowed from a Canadian bank? Is that foreign investment, or is the bank selling us out for its own profit?
THE NATIONAL DEBT
Governments know that unlimited bank loans can upset the economy and they try to control the creation of money through interest rates set by central banks. In times of inflation the interest rate is raised, to slow borrowing and the creation of money, and in times of recession the interest rate may be lowered.
But governments are themselves big borrowers and most of Canada's national debt is for money that was created from thin air by Canadian banks. That's a sore point with Paul Hellyer.
He was a cabinet minister in one of Trudeau's governments, perhaps best known as the minister of defence who merged our three armed forces into one. In 1969 he resigned from the cabinet over a matter of principle.
Hellyer points out that while private banks can create money the Bank of Canada can also create money, and that the Canadian people collect the interest on money created by the Bank of Canada.
Most of our national debt is compound interest on borrowed money, Hellyer says, but if the money had been borrowed from the Bank of Canada the interest -- about $85,000 a minute -- would be payable to the government of Canada.
The Bank of Canada did not have enough money to finance the federal government but neither did the private banks. They created the money they loaned to the government, and the Bank of Canada could have done the same.
In the spring of 1993 Hellyer hired Infometrica Ltd, an Ottawa-based economics firm, to calculate the effect on the Canadian economy if the federal government had adopted and maintained the policy that he had recommended in 1969. A computer simulation of the economy showed that if the policy had been adopted in 1978 we would have had an extra 870,000 jobs and $50 to $80 billion less debt in 1985. Extrapolation of the same scenario to 1992 showed a saving of about $220 billion in the federal debt.[4]
GAMBLING WITH OUR SAVINGS
The banks' ability to create money is a real problem for Canadians who want to save, because banks that can create their own money don't have to pay fair interest on savings. Why should they rent your money when they can create their own for nothing?
But because banks don't pay much interest people who keep their savings in a bank lose money to inflation, and most of us are driven to the stock market and to mutual funds to save for our old age.
That's a problem for a couple of reasons. One is that most of us don't have time to research investments properly.
If the local newspaper and my friendly stockbroker both tell me that Bre-X is developing a gold mine in Indonesia I have no way to check on it but, even so, I might invest a significant portion of my life savings in that mine.[5]
The two things I know for sure about Bre-X are that someone was paid to write the newspaper and magazine stories about it and that, whether the stock goes up or down, my broker will collect a commission for selling it to me.
Now, of course, we know that Bre-X was a swindle. In theory agents of the stock brokerage that underwrote Bre-X checked it out first but, if they were not part of the swindle, they must have been incompetent. Canadian law does not hold the brokerage responsible but the facts remain that it made profits, and that people who trusted it lost money. Some lost their life savings.
If a company like Bre-X had to borrow money from a bank, the bank would make sure there was gold in the ground before it approved the loan. The brokerage that floated the issue did not have to worry about whether the mine was real or not because it did not invest its own money and, even though it was a fraud, the brokerage still collected commission on the stock it sold. It would be a bad idea for a brokerage to float too many frauds but, as long as it doesn't lose its reputation, a fraud can be as profitable as a real mine.
The stock market is a dangerous place for an individual investor. We can buy some protection against crooks and other investment traps by putting our money into mutual funds, but that creates other problems.
MUTUAL FUNDS
Mutual funds are highly-competitive multi-billion dollar corporations in their own right, and the only standard they have for success is to get the highest possible return on their money. That's a problem because many mutual funds are so very big that they can afford to invest only in very big companies.
If a fund has $5 billion to invest, for example, it can't afford to buy stock in a company that is worth only $5 million. Because the fund is just investing, not taking over, it does not want to buy more than 10% of any given company and 10% of $5 million is $500,000. That's only one-tenth of one percent of the total value of the fund, and it's not practical to research and track holdings that small. Even $5 million -- 10% of a $50 million company -- would be only one percent of the fund and too small for efficient management.
So a multi-billion dollar fund has to invest in very big companies -- with total worth in the hundreds of millions or in billions of dollars -- and that's a problem because very big companies can't grow very fast. A million-dollar company might legitimately double or triple its value in a year but a multi-billion dollar company can not. The price of the stock might double, but it's most unlikely that the real value of the company would increase that much.
But mutual funds need growth and the only way they can get it out of the very big companies they buy into is by encouraging managers of those companies to work for short-term profits rather than long-term value. It's not impossible to get both but it is unlikely and hot-shot "turn-around experts who move from company to company know they can produce better short-term profits if they skimp on long-term plans.
The easy way to increase the profits of a company is to gut it. If you shut down research and development, cut back on customer service and use cheaper materials the profits go up for a while. The company itself will go down in a few years but that's no problem to a manager who can move on to another company before the results of his work show.
When a corporate rape-artist moves in the profits go up, for a while, and the price of the stock goes up with them. When the rapist moves on the insiders know it's time to sell, and leave the suckers holding the empty shell of what was once a solid and profitable company.
The perfect scenario for the mutual fund manager is to buy into a company just before a corporate rapist takes over, and sell just before he leaves. If he serves his own and his clients' best interest, the mutual fund manager is an enemy of society.[6]
In a world in which speculators and profiteers are seen as respectable citizens, this kind of rapacity is seen as good business practice.
HIGH FINANCE
Most of the people who start companies get their money from savings, or by borrowing. When a company is doing very well it may "go public" on the stock market to raise money for expansion, but basic development of that type represents a very small share of the business. Almost all of the action on the stock market is the buying and selling of stocks of established companies.
Because they list big corporations and not small companies stock markets steer investments toward big companies and away from small ones -- and away from wannabe businessmen who need money to get started.
Venture capitalists and banks may offer to back small business but the offer may be a hollow one. Banks like to bet on a sure thing, and a business plan that includes new ideas can not be a sure thing. Anyone who can raise a small down payment and get a franchise for a big-name hamburger stand can get backing from a bank, but a genius with a new idea probably can't.
In today's economy financiers are the prime movers of business but when they merge small companies into bigger ones, they create nothing and their net contribution to the economy may be negative.
They think they are a positive factor because they own or control businesses that employ a lot of people, but that's just one side of the story. The other side is that financiers don't start businesses. They buy them with borrowed money and when they borrow the money they create inflation. By consolidating some functions, cutting back on service and laying off workers an investor can increase profits enough to pay off his loans but he creates nothing and he harms his fellow citizens in several ways. He creates unemployment when he consolidates operations and lays off workers and he creates poverty among people who still have jobs because the loans he takes to buy existing businesses debase the currency, and workers' earnings now will not buy as much as they would before. I grant you that some financiers can take over a struggling company and make it prosperous, but these men are the exception. Many financiers who build empires actually create nothing.
SPECULATION
Speculators can also make big money, but they do it at the expense of the rest of us and most of them add nothing to our national wealth.
In 1975 I was a reporter in Kamloops, BC. A new copper mine was about to open near town and a speculator from Calgary made down payments on nearly every house that was for sale, including one that belonged to a friend of mine. My friend sold his house for about $15,000 and, before he had moved, the speculator re-sold it for nearly $25,000.
The speculator made more than $100,000 profit in a month or so, at a time when $10,000 was a respectable year's income, and he set a new norm for the city. Short of a major recession prices will never drop back to where they were because people who paid inflated prices for their homes want inflated prices when they sell. People who owned houses before the speculator came think they have a windfall profit but, because all house prices have risen, they will need all that profit to buy another house if they move. Because all prices have risen, they are actually not as well off as they were before.
HOBSON'S SPIRAL AND THE FORD EFFECT
Our financial industry makes big profits but the rest of us have been losing real income and our standard of living has been in decline for about 20 years now. If this keeps up we will fall into the type of catastrophic collapse I call "Hobson's Spiral."
John Hobson was an English economist who wondered how, in the Victorian age, England could at the same time be the wealthiest country in the world and have some of the most miserable poverty in the world. He realized that if the poor were too poor, the country as a whole could not prosper.
He argued that the economy depends on consumption and that if the poor have no money they can't consume. On the other hand if the rich are too rich they can't consume all they can afford, so the total level of consumption will drop and the economy will slow down. This creates a spiral in which, as the rich get richer, the poor get poorer.[7]
Hobson offered a theory but he could not prove it because he could not raise minimum wages himself. Henry Ford could and, when he raised the minimum wage in his factories to $5 a day, he started the greatest industrial boom in history.
Now we are reversing the Ford effect but most of us ignore the signs of poverty that surround us because we don't want to see them. If I can convince myself that economic losers are lazy, or that they failed to keep up with the times, I can pretend that I'm not in danger myself.
But we are now perilously close to the brink of Hobson's spiral and if we start down that slippery slope we may never recover. When our dollar crashes -- as the currencies of other mis-managed countries have crashed -- some Canadians will starve because we no longer produce enough food to feed ourselves.
When the Mexican peso crashed Mexicans had to stop buying imports but at least they had their own food. If our dollar crashes we will still have to import food from the United States and Mexico, and it will be very expensive.
With an 80-cent dollar hundreds of thousands of Canadians rely on food banks to feed their children. With a 25-cent dollar, some will face starvation. We might believe that in an emergency the government would provide food for the hungry, but if our dollar crashes our government won't be able to help anybody.
A CURE
To protect our future we need to demand that government change our banking system and perhaps bring it under public control. The banks won't like that but when they create money they perform a function of government and, if they perform a function of government, they should be controlled by government.
Certainly, the public debt should be funded by a public bank. It's ridiculous that private banks have been allowed to create public money and then hold the country to ransom for interest on that money.
But whatever we do with national banks, we need local banks too. If the people of Elk's Elbow want their own bank they should have it, and it could be private or run by their local government as they choose. The local bank would be allowed to operate only in and around Elk's Elbow.
And whether banks are public or private, we can't allow the unrestricted creation of money. Banks have to be able to create money to finance new ventures, but they must not be allowed to create money to buy existing capital goods. As we have seen, that devalues all money.
Some businessmen want to buy and others want to sell existing businesses, and that's no problem if they do it with existing money. They could if we had savings banks to hold the savings of Canadians and pay interest on them. Such a bank would not be allowed to create imaginary money but it could cater to the needs of wheeler-dealer businessmen and it would provide other Canadians a reasonable return on savings.
This would not benefit the booming mutual fund business but, since the biggest funds appear to do more harm than good to the national economy, I do not see that as a problem.
Zero reserve banking allows a private company to create unlimited amounts of money. We don't allow the government to do that and I see no reason why a private company should be allowed to. To protect our currency and our economy, we need to re-establish a cash reserve banking system.
We might also consider who banks should be allowed to lend money to. If a foreign investor wants to take over a Canadian business that's one thing, but should he be allowed to do it with Canadian money? Should Canadian banks be allowed to create Canadian money to lend to foreigners to take over a Canadian business? If foreigners want to buy Canada, is it too much to ask that they pay for it with their own money?
We also need to make it easier for people to invest their savings. Under present laws people can save taxes by investing in a Registered Retirement Savings Plan but if they dip into that account -- to start a business or for any other reason -- the money they withdraw will be taxed. A responsible government would encourage savings with tax rebates, but would still allow people access to those savings to establish a new business or for other specified purposes. To be fair the tax rebate would have to be much greater for poor people -- who have to make a greater sacrifice to save money -- than for wealthy people for whom saving is easy.
The stock market is now a venue for predatory economics, but it could serve a useful function. In a rational economy the primary function of a stock market would be to finance new, productive business. We might even consider the formation of a new stock market, to deal only in the stocks of new companies that produce useful goods. Because investment in such stocks would be potentially risky and because it would be beneficial to society, a rational government might forgive some taxes on profits from such stocks.
We should also consider a punitive tax on predatory speculation. Such a tax would be vigorously opposed by speculators, of course, but there is no question that it is justified.
The law discriminates against theft, robbery and fraud because those activities harm both the victims and society itself. Speculation also harms the victims who have to pay inflated prices and it harms society itself because it debases our national currency.
We can't outlaw all speculation because an honest investor may make speculative gains by accident, and because some futures traders have honest motives. If a company promises to deliver a product at an agreed price it must be able to guarantee the cost of raw materials, so futures trading is a legitimate part of some businesses.
If a company actually uses the goods it buys futures in, and if it buys futures only in quantities of goods it can use, there will be no speculative profit and there should be no extra tax. Predatory speculation is easy to recognize, and it can and should be taxed at a punitive level.
When we get the economy fixed, we will be able to afford to make serious preparations for the dangers that we know are coming.
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