There's no free $30 Billion lunch from the Bank of Canada

By Ard Van Leeuwen on 23 June 2010 - 9:22am

There’s a motion coming up for the BGM that calls for the government to lend from the Bank of Canada at zero percent interest rates http://greenparty.ca/motion/g10-p24 . I strongly urge members to vote against this motion.

I hope/trust people remember from Economics 101 that there is no such thing as a free lunch. The finance behind this motion is too good to be true. You can’t avoid the consequences of government borrowing by legislating away interest payments on national debt without some nasty side effects. If this were possible, surely the Conservative government, the Liberal one before that, the department of Finance, or some other responsible foreign government would have used it as a tool.

While it’s true that the government can borrow from the Bank of Canada (it’s been done in the past) and it’s true that you could force a lower rate of interest, it’s not true that you could save money, never mind the tens of Billions we pay yearly to finance the national debt, without equally nasty side effects. If the rate of interest paid on government debt were below inflation and/or there weren’t additional regulations put in place to restrict credit to the market from other sources in an equal amount of new government borrowing from the Bank of Canada (which itself has consequences that need to be worked out) you would end up with upward pressure on inflation.

As Wimpy the Popeye cartoon character used to say: I’ll gladly pay you Tuesday for a hamburger today! (without interest that is and in an environment of steady predictable inflation). Wimpy was no fool. He understood the time value of money and was looking for people to subsidize his lunch. At zero percent interest we would actually be subsidising, and hence encouraging, government borrowing. Borrow 100 Billion this year interest free and over time the real value of the principle would magically erode at the rate of inflation. It would make it easier for a future government to repay that debt with revenues that are increasing with inflation.

This mechanism behind this motion is very much like printing money. International markets would surely take notice if this were ever to become a real Government of Canada policy and correspondingly devalue our currency. Worse, we’d lose credibility in our ability to manage our finances.

The GPC wants to stop paying crushing interest payments on national debt more so than any other party does. And, we are contemplating a budget that does just that. But the way to do it is to begin to steadily pay back that debt, the 'old fashioned way', not by waving a magic wand to finance it at a zero percent interest rate.

Bank of Canada lending at zero percent was the cornerstone of the economic platform of the Canadian Action Party (CAP) in the 2008 election. The CAP candidate I ran against had the same answer for most of Canada’s economic and financial challenges: save $30 Billion annually by financing Canada’s debt at zero percent interest rate through the Bank of Canada. He was a likeable, articulate candidate but every time he said that he lost points on the credibility front.

Free financing from the Bank of Canada is the Canadian Action Party’s baby. Let them peddle their idea and see how far they get with it.

Ard Van Leeuwen's blog
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Comments

Inflation?

Submitted by Michael Vaillancourt on 23 June 2010 - 8:18pm.

I am sorry you are campaigning against this motion Ard, especially since you hold the Finance portfolio on Shadow Cabinet. I don't believe you are an economist, however, and I wonder whether you have the expertise to counsel other members on how to vote. I believe your concerns about inflation can be easily dealt with.

Regarding inflation, this article says:

When the government sells a bond, it is borrowing from the purchaser of that bond; it is as simple as that! When the government borrows from the Bank of Canada, there is effectively no interest on that debt because interest paid comes back to the government as dividend. In this way, the government can borrow whatever is necessary to get the economy moving again without hanging a huge debt burden on the necks of future generations, and inflation can be controlled through reinstatement of the statutory reserves. We pay enough interest now on the debts of our three levels of government (over $63 billion a year, or $175 million a day) for money borrowed privately instead of from the Bank of Canada. We don’t need any more privately financed public debt.

Can you clarify?

Submitted by David Barclay on 23 June 2010 - 9:30pm.

I don't understand this statement, "When the government borrows from the Bank of Canada, there is effectively no interest on that debt because interest paid comes back to the government as dividend."

Doesn't the interest accrue to the Bank of Canada, which is not the same as the operating government, i.e. those interest moneys are not available for the government of the day to use, unless they borrow them again?

The government borrows (invents) money from a bank (BoC or private) to spend/invest. In a closed non-skewed system, the money would stay in Canada continue to circulate and stimulate the economy. But in our open and skewed system it eventually ends up in the hands of a very few corporations and individuals most of whom are outside Canada.

Yes we can have a positive trade balance, but the money earned by exports (mainly natural resources) isn't redistributed to Canadians, it remains as profits by international corporations. Yes, you can buy stock, but very few natural resource corporations declare dividends - they're always 'expanding operations.'

Nevertheless, there is no reason why the BoC can't lend money to the government of the day at a preferential rate of interest. The problem with zero rate of interest, is that it will encourage the government to let inflation rise, so that the original loan will be easier and easier to pay-off with the decreasing value of the dollar, and increasing tax revenues from an inflationary economy.

The rate should not be less than the rate of inflation.

Respectfully, D. Scott Barclay

Making money from thin air.

Submitted by Bram Kivenko on 24 June 2010 - 8:41am.

I don't know why it is so difficult to explain, but maybe if I put it into math terms, it may help.

If the current money supply contains $x and you borrow $y from yourself (ie, the BoC.) Then you each dollar is now worth x/(x+y) dollars. Assuming y > 0, it means everyone who holds the currency now has less real value. In reality this is manifested via inflation.

For those who have been desensitized to the term "inflation", it is a the mild depreciation of value, which in laymans terms translates to: a diminishing confidence in the state currency.

Now, if you actually assign interest to the money you borrow from yourself, then you end up having to pay back (y + i) dollars, where y+i > y. Let's say you had $x of notes outstanding. After borrowing, you had $x + $y of notes outstanding. Once you pay it back, you will have $x - $i notes outstanding. You now have less money outstanding. The value of money is now x/(x-i), meaning you've appreciated the currency. Assuming you don't want that, you must print the equivalent of $i in new currency, thus you are effectively setting the borrow rate to 0%.

This change of currency value creates economic instability. Specifically, it will widen the distribution of inflation possibilities. Inflation would now be in the hands of politicians instead of the governers of the BoC. At the moment, one of the stated directives for the BoC is stabilize the currency (achieved through inflation controls), and the governers are protected from political influence.

In case you don't understand why the threat of inflation is bad even if there is no actual inflation, imagine you have savings to invest. You basically have two options, you can invest in a business venture, or lend your savings to someone who has income, but insufficient capital to purchase something wanted right now. There are many reasons why someone may want to purchase something with borrowed money even though they have regular income. Houses, cars, repairs, emergencies, business operating costs during temporary slowdowns, etc., etc.

A person with money to lend or invest is going to want to earn at least the inflation rate on their money on an annual basis compounded (since this is the effect of inflation.) However, as the predictability of inflation decreases, and the distribution widens, you will be inclined to lend only at higher rates, and for shorter periods of time, since both these actions decrease the risk of losing real money value. An insidious form of protection would be to put inflation protection into lending contracts, which in itself spurs more inflation.

As an alternative, people may seek foreign investments as a means of inflation protection. This secondary effect can seriously damage an economy, since investment simply flows out of the country.

The reality is that any country that does not institute strong inflationary controls separated from government ends up with high inflation. You can look at both Iran and Venzuela as two countries with significant oil exports that can be used to control inflation. Yet, those two countries are currently running at damaging inflation levels because the government has taken inappropriate control of the currency supply prompted by price regulation measures that it cannot afford.

Attempting to borrow for free is an economic policy that will destroy our country.

Agree in principle

Submitted by David Barclay on 25 June 2010 - 10:35am.

Although I believe you misunderstood my question/or I didn't phrase it clearly, in any case here we do agree:

a) Government borrowing from the BoC is risky because the Governor of the BoC can be dismissed by the government of the day, and the Finance Minister can enforce written instructions for the BoC to change its policy. This invites abuse and disables any real consequences for borrowing too much and/or defaulting. A recipe for inflation.

b) Borrowing at zero interest cheats the lender because the borrower is paying back over time with devalued dollars (unless there is deflation, which happens rarely) and encourages government inflationary practices which makes it easier to pay back. This is also in itself obviously inflationary as the cost of money is zero it encourages over-borrowing.

The way to get a handle on the banks running riot over the economy with; hidden overcharging, fraudulent, and gambling strategies is to tax them. As in Europe tax their liabilities (not assets) a tax on the 'risk'. Because the risks they take are paid for by the public when they lose. A sales tax (discourages resale cycling/price manipulation tactics) and windfall profits tax. Finally separate legally into two businesses: their customers' money and their own money.

Respectfully, D. Scott Barclay