THE JOURNAL OF THE COMMITTEE ON MONETARY AND ECONOMIC REFORM

$3.95 Vol. 19, No. 10 • October 2007

C o n t e n t s

5 More than a Mat at Doorstep A Great Forgotten Son of Canada to Clean Up Coal 7 A Historic Brief to the Ontario In many respects we have been deprived but a central bank at its orders. Subsection Legislature of a crucial part of our history. The best way 14(2) of the Act makes clear who has the to describe our plight is by comparing it on a final word in such matters. After the sales 10 Politics, Not Technology, Is the monumental scale with our computer swal- of these properties it is leasing them back Main Problem in the Energy Crisis lowing our key files. Practically, all public on 25 years leases. With the second major 11 Disentangling a Knotted World and university libraries, coast to coast, have bailout of our banks in little more than a 12 Gospel for Year One of RM purged their shelves of crucial books that of- decade, we should try foreseeing what form (Risk Management) fend the mighty on important matters. That the next apparently inevitable bank bailout 13 A Monarch Currency in Need has been the fate of one of the most gifted will take. It could be the reprivatization of Crutches men to have come from Canada, Gerald of the Bank of Canada on the US model. G. McGeer, Mayor of Vancouver, member Today, accordingly, Canada needs McGeer’s 14 Climbing the Derivative Ladder of the Canadian and British Columbian books more than it even did in 1935. 15 The Detail Governor Dodge Forgot legislatures and the federal Senate. He was McGeer’s achievements began with a 16 Globalization’s Poisonous the man who in the depth of the Great lengthy, warming-up battle against the rail- Gas Balloon Depression of the 1930s raised the banner ways to curtail the injustice in the rates of monetary reform. More than anybody charged British Columbia. under the Crow’s 17 The Great Inflation Mystery else he was responsible for pressuring Prime Pass system. Right from the beginning you Still Unsolved Minister William Lyon Mackenzie King sense that behind the man, his several pub- 19 The Ever Thinner Narrower into nationalizing the Bank of Canada some lications, and his practical politics lay a Newspage four years after it was founded. rarely gifted mind mated to an exceptional 20 Rogue Financing Knows It wasn’t cheaply that Canada bought valour. No Fatherland out the 12,000 shareholders of the central I have spent close to a half century en- bank. The knowledge of what Canada got gaged in monetary reform. Never, however, back from that deal has been buried deeply had I quite encountered McGeer’s ability to beneath the sod. Life rolls on as we re- concentrate in a single phrase what banking peatedly go on bailing out our deregulated or many other matters are about. The banks, banks as though Canada’s purchase of the said he, “sold the public what they didn’t Bank of Canada had never happened. Yet have, or in other words they sold money short. the repurchase of those shares helped save And for that the only thing needed is the this land during the war. During the three absence of a conscience, since it transforms decades after that conflict, it financed much on a potentially ever larger scale the need of of Canada’s transition from a semi-rural into the borrower to surrender to the creditor.” a developed land. Since the 1980s and es- Try to improve on that! pecially the 1990s it is never mentioned by the government though the Bank of Canada A High School Dropout with Act, is still intact on our law books, unused, a Mind on Fire when it comes to the crucial matters for I have encountered elsewhere that type of which it was nationalized. gifted mind, where its owner as an adoles- Today, for example, our government is cent becomes impatient with school courses, selling off its choicest urban real estate be- and before you know it has dropped out of cause “it cannot afford to maintain it prop- school to learn better alone, entrusting to erly” even though it has not only a bank, Continued on page 2 Forgotten continued from page 1 in the saddle want to avoid encountering his own scouting what course to take, where, them on the printed page, in their sleep, or and when. That happened to McGeer in his in libraries, before or after sunset. mid-teens and he went to work as a metal Learning How to Finance Peace FOUNDING EDITOR moulder, and even became a militant mem- John Hotson 1930–1996 ber of the moulders’ union. But then he real- from the Lessons of War PUBLISHER–EDITOR ized that to effect social change, he needed a Here is an early sample, on Financing William Krehm position of some influence. So then in a few War, that leaves no doubt about how to ([email protected]) months he prepared for university and took finance a durable peace: “Just twenty years CARTOONIST a law course. He did a similar job on mon- ago the governments of the leading na- Allen Good etary theory, and came under the spell of the tions of the world were confronted with INFORMATION SECRETARY late President Lincoln, author of the Civil the problem of financing a war to the fabu- Herb Wiseman ([email protected]) War greenbacks, paper money bills with lous sum of $400,000,000,000 in direct nothing except everything behind them, governmental expenses and an additional WEBMASTER John Riddell that is the government’s entire credit. $400,000,000,000 of loss due to the de- Even today McGeer’s books – brilliantly struction of property and the curtailment Economic Reform (ER) (ISSN 1187–080X) is published monthly and leanly written – leave an opponent of productive activity. When the war com- by COMER Publications floored bleeding with cutting insights. They menced, many laboured under the delusion 245 Carlaw Avenue, Suite 107 are, however, not to be found on even Van- that it would not continue indefinitely Toronto, Ontario M4M 2S6 Canada couver public library shelves, either academ- simply because the cost would exceed all the Tel: 416‑466‑2642, Fax: 416‑466‑5827 ic or municipal. Yet they brought this land money in existence. As it turned out, the Email: [email protected] Website: www.comer.org the nationalization of the Bank of Canada, longer the war continued and the greater largely because Prime Minister Macken- the expense grew, the easier the problem of COMER Membership: Annual dues zie King, leader of the opposition during financing it became. (includes ER on request plus 1 book or video of your choice), in Canada much of the Depression, could simply not “During the war some 65 million men CDN$50, foreign US$45 withstand the dynamism and passion of were mobilized as combatants, and all were Economic Reform Subscription only: McGeer’s mind. How much Mackenzie carried on governmental pay-rolls. Another One year, 12 monthly issues, in Canada King appreciated what McGeer was talking army even greater was engaged in producing CDN$30, Foreign US$35 about, apart from its immediate political army supplies and war materials. Yet there Send request and payment to: convenience, is open to discussion. The Ca- was never any shortage of money to meet COMER Publications nadian Cooperative Federation, forerunner the current cost of the War. For a period after 245 Carlaw Avenue, Suite 107 of the present NDP, should rate higher in the war, prosperous times continued. Eleven Toronto, ON M4M 2S6 this regard, but never risks mentioning the years after the Armistice was signed, how- ER Back Issues: CDN/US$4, includes important role of its predecessor in support- ever and just four years after the gold stan- postage; additional copies same ing the nationalization of the central bank. dard was reestablished in Great Britain the issue, $2; additional issue same order, That, however, alone made possible the world’s most tragic depression commenced. $3. Send requests for back issues to Herb Wiseman, 56 Robinson Street, transformation of Canada into an actively From one end to another of Christendom, Peterborough ON K9H 1E8. social-minded democracy during at least governments acknowledged bankruptcy. three decades of the post-war. Debt repudiation became the order of the Copyright © 2007 It was due to him as much as to any sin- day. Huge armies of unemployed and des- COMER Publications All rights reserved gle person that the Bank of Canada financed titute workers appeared everywhere and 16% of Canada’s war expenses virtually democratic government fell into a condition Permission to reproduce is granted if accompanied by: interest-free through the federal bank – a of impotence. Strange, is it not, that while “Copyright © 2007 COMER Publications. considerably larger percentage than either there was a plentiful supply of money for the Reproduced by permission of the UK or the US, both of whose private war, that with peace a shortage of money for COMER Publications” banks were privately owned at the time. The peace should everywhere appear? Publications Mail Agreement 40018485. US Fed still is. “Thus we see that the comparative short- Occasionally his writings may be pos- age of money which we now suffer in peace as Postmaster, please send address corrections to: sibly too laden for our generation’s secular contrasted with its abundance in war time, is COMER Publications taste with Biblical references to usury, and to due to a definite and specific change in mon- 245 Carlaw Avenue, Suite 107 Christ casting the usurers out of the temple. etary policy. These extraordinary results have Toronto, Ontario M4M 2S6 Yet that is a sin readily to be forgiven when been accomplished by the simple process of LAYOUT the suppressed message is so important for suspending and restoring the gold standard Tony Koch ([email protected]) saints and sinners alike. I owe the copy of his to create an abundance of money. Surely if Pagecraft Computer Services The Conquest of Poverty that I am reviewing money can be provided when the primary PRINTING AND DISTRIBUTION to a loan from Betsy Wood who runs a small purpose was to finance war, there can be no Watt Solutions Inc., London non-commercial private library of McGeer good reason why there should be a shortage Printed in Canada on recycled paper. and works to keep his flame glowing. The of medium of exchange required to finance tales that McGeer tells in it are simple, un- the production and distribution of wealth for adorned, overpowering. No wonder those work in the advancement of a cultural civili-

 | Economic Reform October 2007 www.comer.org zation. War-time and post-war policies prove “The power to create, issue and circulate growth of the bank multiplier – because that is the most important and far-reaching the medium of control, which should be the difference between denominator and of all the powers of modern government.” recognized as the supreme prerogative of numerator of the key ratio had become too Let us move on to yet another overpow- government, now forms the stock-in-trade indistinct. But given the notable structural eringly simple treatment of an ancient cliché of the business of our super-banking system. developments since then, every glimpse of by McGeer: our inescapable, old friend, This functions as the servant of usury in the the clefts opened up in our economy, be- Supply and Demand (p. 4): “The law of realm of high finance. comes informative.” supply and demand is a fundamental law “No factor has played so great a part in McGeer’s observations on the changed of nature. But, like money, its real meaning this unfortunate development as that of the role of taxation in a society that has learned and true purpose are little understood. Of gold standard. It was designed to prevent to handle its monetary system. could not course, everybody is subconsciously aware governments exercising their power to issue be clearer: that no one can survive who does not eat, currency as a medium of exchange serving “Here then we observe that the power of drink and shelter the body and throw off human needs. The production of gold, and the government to create money places it the materials required to sustain life, that not human needs, fixed the volume of cur- in a position to finance all public enterprise the instinctive drive to live creates. This de- rency in issue. The supply of gold, as this without cost to the taxpayers. But there is termines that the demand for life’s require- depression has compelled us to realize, bears something even more important than that. ments will always be satisfied by human no relation whatever to the capacity of the By this course the government is able steadi- intelligence from whatever supply there is people to create and distribute wealth in the ly to increase the volume of consumers’ of life’s necessities. service of mankind. buying power required to serve the demands “[But] while progress is dependent upon “Fortunately for humanity, such monop- of progress. For example the $100,000 the the demands of the human family for neces- olies are always blind. Dominated by greed, government has spent in payment for, say, a sities, it is possible to interfere with this law they invariably sow the seeds that produce school has gone into circulation. It has been so that progress may be delayed, notwith- their own destruction. The private money used by all those engaged in providing the standing that both supply and demand do system, having secured the power to limit material and labour out of which the school exist. An improper administration of the the supply of money so that all – govern- was created with buying power. They in monetary system produces this evil result, ment, corporation and individual – would turn have bought the needs and comforts let us examine the part that money should have to borrow at interest, proceeded to and conveniences of existence. The social play in helping the law of supply and de- pyramid obligations into a mountain of system is thereby enriched by an added mand really function. unpayable and inextinguishable debt claims. volume of medium of exchange put into “During civilization’s progress, mankind The private money system having thus circulation as a result of the creation of the has moved from a condition of natural ex- made progress impossible, it must now give real wealth of the school. The community at istence, when the business of life’s existence way to a governmental administration of the large has a school representing real wealth in was purely an individual enterprise, until monetary system.” the value of $100,000 and $100,000 in buy- today, when individualism has ceased to ing power. The books are balanced. exist and life now depends on collective A Hard Look at What WWI Taught Us “There is the cost of maintaining and op- effort. When advancing intelligence made About Deposits erating the school, of course. But when the life more secure and comfortable and con- Since the war, bank deposits have been government creates its own paper money venient living became possible that created much more carefully considered than ever or credits in a national banking system to a demand for a medium of exchange. before. The bankers have as a result been finance the school’s operation, a continuous “Money was invented to satisfy this de- able to create bank deposits by the simple stream of purchasing power is put into circu- mand. It is therefore a simple tool of trade, process of making credit entries in their own lation. That increase is required to support man-made and man-controlled. It was in- books. (See Table 1.) the greater demand for the increased buying vented to assist the law of supply and de- Thus during the war period the banks power needed to purchase the increasing mand in the realm of progress. Primarily it more than doubled the total amount of supply of comforts and conveniences which should serve the purpose of helping unlim- moneys alleged to be on deposit. educated people desire. ited numbers of people create and distribute In Economic Reform I have written on “Now let us assume that all the public wealth in human service through an effec- this phenomenon: “The bank multiplier works and social services now being main- tive division of labour and intelligence. gets applied to the liquidity pools of each tained on a niggardly basis by national, pro- “Like water in an irrigation system, mon- type of non-banking corporation in turn. As vincial, state and municipal authorities were ey must be circulated in the social system as a result money creation at the previous level financed by the issue of national currency the means of sustaining the production and becomes mixed up with the legal tender or and credit. and the government were under development of life’s needs…. Today, how- near-money base at the next level. Hardly no obligation to arbitrarily withdraw from ever, under the private monetary system it surprising then that the multiplier I had is primarily used for acquiring wealth. The tracked down mounted from the 12 in 1939 Table 1: Bank Deposits private money system has changed from to 376 in mid-1998. But that of course was (millions of dollars) a simple tool of trade into a power that before even relatively simple derivatives had negatives the law of supply and demand, been brought in to befuddle the figures fur- UK Canada US and appropriates to the service of the few ther. In view of the commotion around the 1914 5,000 1,000 18,000 the entire wealth-creating power of modern millennium change, I threw in the sponge 1920 11,500 2,400 37,000 civilization. around 2000 in trying to identify the rapid Increase 6,500 1,400 19,000 www.comer.org October 2007 Economic Reform |  circulation any sum other than the power talism. Even some of its most aggressive This will have to be collected whether they necessary to maintain the effective buying people passed through these stages – Milton appear as interest or as straight fees. Entrust power of the exchange medium. Govern- Friedman, for example. However, a few lin- that to a government bank, not only with ments could then usher in an era of progress gering zealots, mostly belated discoverers of different technologies, but with technolo- in governmental service to the people that a portion of the intriguing record of banks gies that are changing all the time, could would eliminate any suggestion of unem- and banking who announce that fractional only mean that the effective commercial ployment. Wages could be maintained at all reserve banking is in fact “immoral” and interest charges will move up We would be times and in all circumstances. People could hence must be abolished. wise to consult McGeer on this matter while be paid to go to school if there was nothing One should not too readily proclaim reclaiming the social advantage of his great else for them to do.” institutions that reach back several centu- legislative victory. ries fit only for abolishing, without having First he settles accounts with the gold No Government Need Suffer carefully studied what purpose they may standard as a useful means of handling any Bankruptcy While Its Power to have served and what serviceable and more contemporary social problem (p. 57): “We Create Currency Is Not Fully Used humane institutions are available for their have learned that the promise that economic “No government need suffer bankruptcy replacement. Slavery itself was not only and social security could and would be while its powers in the realm of currency continued for centuries during which in sustained by the management of the private and credit remain unused. To save itself theory the Catholic church was opposed money system cannot be fulfilled. In ad- from destruction by the dictatorship of to it. William Wilberforce and his effective dition to that, we have been compelled to the Money Power, democratic government stand against slavery significantly followed recognize that the international gold stan- must establish a national banking system. the spread of the steam engine that offered dard is not an effective means of regulating In making the change, it should be recog- a substitute for humans as power engines on international trade and that the adverse bal- nized that national banking and commercial land and sea. It also contributed to the sup- ances which unmanaged international trade banking are and should be treated as sepa- ply of precious metals which replaced slaves develops cannot be paid out of the gold rate and distinct functions in the monetary as a medium of exchange. reserves available. In the future we must, system. The national banking system should In trying to deal with the problems of therefore, segregate monetary from non- be confined in its operation to the creation, an ever accelerating, ever more globalized monetary factors and recognize that mon- issue and regulation of the circulation of and deregulated economy, made subject to etary management, other than providing the domestic and international medium of a compulsion of exponential growth to con- the economic power which an effective cir- exchange necessary to maintain government tinue gaining altitude to survive, our 100% culation of the medium offers, should have and the trade and commerce of the nation. Money friends should bethink and answer little or nothing to do with the control and The merchant banking system should be how are they going to bridle and command regulation of factors and institutions which confined to the business of serving the pri- this beast. Through the identical govern- are purely social, economic and political. In vate commercial needs of the nation. The ment apparatus that is already so helpless at the past, our inability to segregate and ad- former is essentially a private enterprise, running its own specific affairs? minister monetary and non-monetary fac- while the latter is a normal part of the pri- In his work published at the depth of the tors has been very largely responsible for the vate enterprise of a capitalistic system.” Depression McGeer avoids stepping into impotence of government and the failure of Here we have a sober disposal of the prophet’s. robes, and keeps the basic eco- our monetary system.” notion of “100% money,” that even ar- nomic implications of money in mind. To gues that any sort of banking is “immoral.” achieve this, he makes a rational distinction Enter a Hint of Systems Theory “100% money” arose inevitably during the between public and commercial banking. Before Its Day Depression depths in the 1930s. When a It was his clear thinking on the subject This approaches the basic view of “sys- single bank closes its doors. unable to hon- that made possible his break-through in his tems theory,” long familiar to scientists our the claims on it, it is often enough to campaign to nationalize the central bank. A and academics. This regards society and start a run on all banks. Imagine then the central bank requires a different type of per- the economy, too, as a structured complex situation at the time of President Franklin son and organization than one that looks af- of systems composed in turn of subsys- Roosevelt’s first inauguration in 1933, when ter the affairs of the country as a whole from tems, each with it own code that must be no less than 38% of the many thousands the commercial needs of individuals and respected for the entire super-system to of US banks had done so. Roosevelt had commercial corporations. And commercial function. Clearly this was incompatible to declare a bank moratorium to meet the banking in turn is developing apart from with the official economic doctrine that sees emergency, and on its expiry to renew it. In- consumer banking payments such as credit everything in the economy determined by evitably many theorists gave up on capital- cards not only for the benefit of financing a “pure and perfect market,” defined as of ism and banking – included amongst these companies’ but for individuals’ purchasing such infinitesimal size that nothing done by were Henry Ford and Thomas Edison – two funds and financing. To thrust this onto a individual agents can affect price. All this, very eminent industrialists. As did many single breed of executive is to play with fire. of course, was in order to apply some infini- economists for a while. But when the bank- To begin with these consumer financings tesimal calculus which is mistaken per se as ing system and capitalism recovered after require a different technology, which can a guarantee of scientific validity. having been put on a severe regimen with no be very costly Not only more costly, but the Let McGeer himself tell his tale (p. 59): small help from World War II, the Hundred private banks kept out of banking proper “Communal life is sustained in much the Percent Money prophets mostly changed will have to make up with higher fees, or same way [as that of private citizens]. An their beliefs and reverted to orthodox capi- openly or hidden higher interest charges. inexhaustible supply of the medium of

 | Economic Reform October 2007 www.comer.org exchange must be established. This is now We should have known that progress is Japan and Germany to predict how long it available. The means of maintaining the wholly dependent upon education, for it is would be before those two powers would medium of exchange in circulation must be upon the advancement of intelligence that once again become formidable industrial developed. Wages and consumers’ buying we must depend to provide administration competitors on the world market. Schultz power must be sustained and new capital with increasing efficiency.” concluded some 20 years later that he and must be issued as required from time to Here you have the view that investment his colleagues had guessed so wrong because time. Once this has been done, the mon- in human capital – in education, skills, they concentrated on the physical destruc- etary system can begin its work. What they and hence in the preservation of the vessels tion and ignored the fact that the highly will produce, how they will use it, the type holding these valuables – human beings – is educated labour forces of those powers had of social system they maintain and the cul- the most productive investment a country come out of the war essentially intact. It tural progress they achieve, depend upon can make. Theodore Schultz reached that netted Schultz a so-called Nobel Prize from the intelligence and industry of the leaders conclusion in the 1960s based on his own the Bank of Sweden, but after a decade or so in the innumerable structures of the social mistaken forecast and those of hundreds of his achievement was forgotten, After all, at system. The work of national, provincial, other American economists sent to defeated that time governments were still and more state, county and municipal government must be coordinated to the end that all con- tribute towards achieving ordered progress. More than a Mat at Doorstep “Governments with power to create and issue money and credit need not borrow to Clean Up Coal capital. By the adoption of a sane attitude towards money and credit, the financing The Globe and Mail (10/9, “Clean Uses to oil sands processing,’ says Mr. Clements, of public works and social services can be of Coal” by Kevin Bambrough, Sprott Asset who adds, ‘Chemicals produced by gasifi- changed from one of disastrous expense to Management), informs us: “Allen Wright, ers could be adapted to produce nitrogen the taxpayer into the general betterment of CEO of the Coal Association of Canada, for fertilizer, chemicals for almost anything the social system, In making the change, it sees the future of coal through a pragmatic – polymers, plastics.’ should be recognized that national banking lens: ‘There’s no doubt that we’ll continue “Mr. Clements says an Integrated Gas- and commercial banking are, and should be to rely on coal as a valuable part of the ification Combined Cycle (IGCC) facility treated as distinct functions in the monetary global energy mix. Considering Canada’s produces electricity by combusting cleaned system. The national banking system should significant coal resources, it is not a question syngases in a turbine and by capturing waste be confined in its operation to the creation, whether we will continue using coal, but heat, which is exhausted to generate steam issue and regulation of the domestic and how can we use it better.’ in a boiler. ‘This way you are running a gas international medium of exchange neces- “Canada has at present sufficiently prov- turbine cycle and a steam cycle.’ sary to maintain the government, trade and en coal reserves to last more than 230 years. “‘When CO2 capture and sequestration commerce of the nation. The merchant Rising concerns over energy security and the technology is added, an IGCC is a near banking system should be confined to the environment have led to concerted efforts zero-emissions polygeneration facility. Even business of serving the private commercial to deploy technologies that will enable the its waste CO2 – a greenhouse gas – can be needs of the nation. use of all this abundant resource responsibly used for industrial purposes such as en- “I am fully aware that the reconstruction and maximize its economic usefulness. hanced oil recovery, or stored safely under- of the private money system is not in itself “With 12 billion tonnes of near-surface ground. Mr. Minnes says that while IGCC a panacea for all economic problems that coal reserves, Sherritt is Canada’s largest coal technology has been successful in countries confront us. We have been compelled to producer. Company spokesman Michael around the world, it is new in Canada. recognize that the international gold stan- Minnes says, ‘There is no question that Sherritt’s proposed Dodds-Roundhill Coal dard is not an effective means of regulating coal will be part of the energy mix moving Gasification Project in Alberta has the po- international trade and that the adverse forward. It makes sense to embrace the asset tential to incorporate an IGCC facility into trade balances which unmanaged interna- and the technologies that enable its respon- the overall footprint of its gasification proj- tional trade develops cannot be settled by sible, profitable use.’ ect, which would make it Canada’s first fully the gold reserves available. In the future, “Among the innovative options being operational IGCC facility. we must then segregate monetary from pursued by Sherritt and others is coal gas- “The production of syngas through coal non-monetary factors and recognize that ification, which can be configurated to pro- gasification would provide an alternative to monetary management, other than provid- duce efficiently synthesis gas (syngas) of natural gas now used to produce stead steam ing the economic power which an effective hydrogen, as well as electricity, steam, and and hydrogen for bitumen extraction and circulation of the medium of exchange of- a host of industrial byproducts through a upgrading. fers, should have little or nothing to do with near-zero emissions process. “He adds, ‘With IGCC, you use a low- the control and regulation of factors and in- “In Ottawa, Natural Resources Canada ranking fuel (coal) to create high-value stitutions which are purely social economic research scientist Bruce Clements heads products. It is a responsible use of fossil fuel and political. Much of the failure that now the CANMET Combustion Optimization with low to zero impact on the environ- exists is due to the fact that we have as- Group. He says a key function of a gasifier ment.’” sumed that progress could be controlled by is to convert coal into syngas. That sounds to our ears as a giant patter those empowered to regulate the flow of the “‘Once you have syngas, it can be used to of steps in the proper direction. medium of exchange in the social system. produce hydrogen, which is very important W.K. www.comer.org October 2007 Economic Reform |  desperately writing off even their physical “The report was made at a time of great rency (or the creation of credit in a national investments – roads, bridges, battleships, uncertainty, when the people of Great Brit- banking system) forces are set in motion buildings in a single year since it helped ain feared the consequences of abandoning increasing profits and wages and additional create misleading deficits on their books to gold. For that reason the report was guarded spending arises. (Section 24) push down labour costs. And here was Mc- and less pointed than if it were by the same “8. Gold reserves are held solely to meet Geer some thirty years earlier having reached men today. However, from the main report temporary deficiencies in the balance of in- the same key conclusion without the guid- and the observations filed by Committee ternational payments. (Section 340) ance of a world war! It was a conclusion members, an almost complete scheme of “9. The circulating media consist over- that could have saved anything positive that managed currency, and planned economy whelmingly of paper money and bank de- came out of WWII. Instead we seem well and regulated trade may be secured. posits. It is this volume of purchasing power launched towards the next world conflict. “Let me draw to your attention the follow- that deeply affects the price level and not ing observations to be found in the report. the amount of gold which may be held in A Chat of Roosevelt with Abe Lincoln “National Banking reserves. (Section 45) In the McGeer book being reviewed, “1. The Bank of England ought to be “10. There is nothing inherently imprac- there is a reference – during a long imagined formed into a public corporation. (p. 240) tical in the government’s power to deliber- interview between President Franklin Roos- Public Credit ately control the price level. We should be evelt and Abraham Lincoln who did issue “2. The vicious circle is now complete. ready to attempt the task to gain experience his paper greenback money with no gold or The decline of new enterprise has reacted by practice. (Section 210) silver reserves. In this McGeer pursues the adversely on profits and prices, and the low “11. International trade can and should main purpose of counselling the new Presi- level of prices stands in the way of new en- be regulated and controlled by deliberate dent of the United States Franklin Roosevelt terprise. It is for this reason that some of us management. (Section 41, Addendum I, through the mouth of Abe Lincoln who think it may be necessary to invoke govern- page 201) may not have thought out monetary theory mental enterprise to break the vicious circle. “In the broad principles and administra- in all its scope as McGeer did. (Section 316) tive policies laid down by the Macmillan Mr. Roosevelt is presented asking of Mr. “3. The best hope of a remedy lies in a Committee, there is nothing proposed that Lincoln filling in for Mr. McGeer: “Other policy designed to increase the volume of is either unique or new. The recommenda- than your speeches and messages to Con- purchasing power. tions it offers are based on the truths that gress, have we available any authoritative “4. It is not necessary that the volume the ancient Hebrew writers recorded as the modern opinion that now endorse and of note issue (a fortiori, of the creation and inspired laws presented to humanity under recommend the ideas you proposed to Con- the issue of national bank credit) should the direction of God. They recommend the gress during your Presidency? continue to be regulated as now by refer- management of the medium of exchange.” Mr. Lincoln: “Yes. The Committee of ence to the amount of gold held in reserve. the Committee on Finance and Industry (Section 148) Are We Preparing the Ground appointed by the British Government under “5. Since the bankers as a whole under for WWIII? date of November 5, 1929, which sat under banking practice maintain a cash propor- There was something that at first sight the chairmanship of the Right Honourable tion of not the amount of gold which may seemed unbelievable. Here in our enlight- H.P. Macmillan, KC, now Lord Macmillan, be held in reserve (i.e., the legal tender paper ened land there had been a native son – re- filed with the British Government under money borrowed from the Bank of England mote from the great centres of learning date of June 23, 1931. It ruthlessly exposes or the Department of Finance in Canada – had on his own, disentangled better and the misguided nature of the fundamental [the Bank of Canada was still not founded earlier than John Maynard Keynes himself fallacies that bankers and financiers have even as a private institution at this time]), the mysteries of money. For during the first tried to maintain. The report recommended the bulk of the bank deposits arise out of year or two after the crash of 1929 – as in an entire change in monetary management actions of the banks themselves, for granting his Treatise on Money published in 1930 by stating: ‘It is not advisable or indeed loans, allowing overdrafts and purchasing – Keynes was still considering using interest practical to regard the monetary system as securities, as banks create a credit in their rates “a l’outrance” before abandoning that an automatic system grinding out the right books which is treated as the equivalent of a omnibus prescription of equilibrium theory. result as an automatic system of natural deposit of money. (Sectors 71-74 inclusive) And by then McGeer must have been deeply forces aided by a few maxims of general “6. The theory that government expendi- involved in rethinking the whole corpus of application and some well-worn rules of tures in the promotion of public enterprise economic theory. let alone putting it into thumb. The main objectives of a sound and social services is restricted to the ac- Biblical terms and into the mouth of Abe monetary policy which are, among others, cumulated savings available for investment, Lincoln. It was only with his final magnum the maintenance of a parity of foreign of is erroneous. When governments distribute opus, The General Theory of Employment, the foreign exchange without unnecessary wages by financing public enterprises with Interest and Money that first appeared in disturbance of domestic business, the avoid- national currency and credit, the volume of 1936, that Keynes finally parted way with ance of the credit cycle and the stability of capital for investment is increased. (Section benchmark interest rates to keep society on the price level, cannot be obtained except 47 of Addendum I, page 203 and section 24 the straight and narrow path. by the constant exercise of knowledge, judg- of Main Report) That difference between continuing sup- ment and authority by individuals placed “7. If governments pursue an inflation- pressing the work of McGeer and giving with all the resources and every technical ary policy, i.e., meet expenditures not out it the attention that it so dramatically had device at their disposal.’ of revenue, but by the issue of paper cur- earned could be no less than World War III!

 | Economic Reform October 2007 www.comer.org But before I chose that conclusion, I felt I had some checking to do. Why did Keynes and other distinguished university- A Historic Brief to the Ontario trained economists tarry so long even after the 1929 crash and the Depression, which Legislature had driven industrial magnates espousing 100% money? Why did bank and academic With the failure of our government to and cupboards. And the Mayor of Toronto economists still cling to interest rates as the make use of the Bank of Canada for the pur- has threatened to shut down a recently com- means to a balanced economy? poses for which it was bought out in 1938, pleted subway line. All this can be traced A couple of hours at the University of the resources that used to go into improved back to the deregulation of our banks. Toronto Library confirmed that the books educational and social services have gone And to cope with these emergencies, of McGeer are distinguished absentees from instead to redeeming our banks from their COMER, the Canadian Action Party and its shelves. Two copies of his Conquest of Pov- repeated gambling plays. Tiding of those others are once organizing a push to use the erty have received shelter at the University’s connected with subprime mortgage debt Bank of Canada for the purposes for which Catholic college, St. Michael’s, undoubtedly have just begun pouring in. it was nationalized in 1938 and made it pos- because of its heavy use of the Scriptures. So long as the nationally owned Bank sible to handle its costs for its part in WWII I sought out the standard literature on of Canada financed much of the federal more efficiently than either the US or the Keynes seeking how the great Keynes had government’s infrastructure projects – and UK, that had private central banks. A lot come so badly behind this self-taught man on occasion those of provinces and munici- of effort on the part of many municipalities from beyond those Great Waters and high palities as well – the net interest paid on such in both the US and Canada has gone into mountains. I reviewed works that I had debt ended up as dividends to the Bank of municipal initiatives for this goal. not consulted for many decades. The work Canada’s sole shareholder, the central gov- To make our public aware of these past of D.E. Moggridge, a Cambridge econo- ernment. However since the latter 1980s, efforts of municipalities pretty well across mist particularly close to Keynes, but suf- the bailout of our banks from their mam- the country we are grateful to André Mar- ficiently independent to appraise him in all moth losses led to the increase of federal debt entette, of Lake Shore, Ontario, a suburb of his strengths and weaknesses. Keynes’ great held by the private banks from 6% to 22%, Windsor. André has gone to the trouble of gifts were handicapped by his social milieu. of the GDP, at the same time that interest tracking down the record of the presenta- McGeer’s encouraged the development of rates were pushed up to “lick inflation.” tion to a Committee of the Legislative As- his highly independent mind. But what the government called “infla- sembly of Ontario commission on February Moggridge in his book Keynes (Univer- tion” was in fact mostly the effect of the shift 24, 1993, a group organized specifically to sity of Toronto Press, Toronto and Buffalo, of government borrowing from the BoC, deal with the financial crisis that the bank third edition) paints a picture of the aca- which had previously cost Ottawa nothing, bailout was beginning to produce among demic society in which Keynes grew up and to the private banks as the same time as in- our municipalities. worked. His father, a distinguished econo- terest rates were being pushed into the skies. Particularly noteworthy is the degree of mist and university official, was part of that That was the major factor in running up access that groups questioning the policies of formative setting. Keynes saved his most the debts of all levels of government. Since the Bank of Canada used to have to both fed- cutting criticism not for the “self-balancing 1988 banks have been allowed to acquire eral and provincial governments. For years market” prophets who were his teachers and debt of developed countries without a down that has no longer been the case. Limitations colleagues, but for the politicians who nego- payment, on the false ground that it was of space make it necessary to cut the presenta- tiated the Peace of Versailles who were with- “risk-free.” The rise of the price level was in tions. Of the three speakers cited, two, John out an inkling of the transfer problems that great part due to the very shift of so much H. Hotson, the head of the Committee of could not be dealt with unless the Germans government debt from the central banks to Monetary and Economic Reform and Harry were allowed to earn the foreign currency the private banks. For this came from $80 Pope, professors respectively at Waterloo and by helping to reconstruct the damage they billion of federal debt that the banks now Ryerson University have since passed away, had wrecked in France and Belgium. But to came to hold, as compared to about $20 bil- but their work lives on to inspire us. fill his lungs with really fresh air, he relied lion before 1988. But these very high rates “Mr. André R. Marentette: I’m the chair- largely on the Bloomsbury set of writers and that, after the end of the reserves are the man of Canadians for Constitutional Mon- painters, rather than on economists. But only measure left to “fight inflation,” actu- ey. We are a non-partisan group promoting rather than risking a clean quick break with ally contribute to it. The Bank of Canada non-interest-bearing loans of government- the economic school of Alfred Marshal, pushed up interest rates to unprecedented created money.” friend of his family and his own teacher, levels, and thereby caused the price level to he just naturally watched his manners as heave up still further. So the federal govern- Lures and Fictions of Deficit Problems a well-bred English lad should. He simply ment to control the financial earthquake “Mr. John H. Hotson: I’m here to talk had to “ooze” out of the world of Marshall. of its own creation downloaded onto the about the deficit problems that the Ontario And that does takes time. Unfortunately the provinces social programs without adequate government shares with so many other gov- world was kept waiting until Gerry McGeer funds to pay for them, and the provinces ernments, and that is what the Canadians came along. But instead of celebrating what passed on the compliment to the munici- for Constitutional Money is all about. he put on their law books his fellow coun- palities. That is why our hospitals have for “Deficit reduction is all the rage today, trymen have put him under wraps. the past decade and more been turning away but few of our would-be deficit-cutters seem William Krehm patients, and bedded others in the corridors to consider is that cutting expenditures or www.comer.org October 2007 Economic Reform |  raising taxes would make the present depres- members representing cities and towns its legal money, was 68% of M1 and 27% sion worse. The world did not end the Great where 80 million Americans live, have passed of M3. By 1992 it was still 64% of M1 but Depression by balancing government bud- resolutions supporting the Sovereignty loan only 8% of M3. The transaction balances gets. The near-zero interest rates of the late petition. So we can be confident that the had fallen from 40% of M3 to a mere 12%. 1930s, though helpful, could not induce enabling legislation will be introduced into It’s because of the liquidity shortage, which sufficient private borrowing and spending this session of Congress. the bank has caused, that interest rates have to induce prosperity. “The Sovereignty loan plan has spread far risen from their near zero rate in 1945 to the “Let us look back to what we learned beyond the US. I had the pleasure along with 1980s peak of over 20%, before falling to from and then forgot from the Great De- Professor Bob Blain of travelling through their present 6% or 8%. which is still high.” pression. The Depression was ended only New Zealand for five weeks, spreading the On other occasions John Hotson, al- when central governments all over the world word about the Sovereignty loan petition. If lowed more time, would explain money drafted their central banks and forced them I had more time I would like to talk about spent into existence by the government to create a flood of new money to finance New Zealand as the only democratic country of Canada for government purchases and massive government deficits at near-zero on earth to get out of the Great Depres- paid for with paper money or bookkeep- interest rates. These massive deficits, up- sion before the War forced the monetary ing entries meant that interest rates were wards of 25% of Gross National Product for expansion that brought about the end of the largely kept out of our price structure. But several years, resulted in a real rise in private Depression everywhere else. They did it in chartered or commercial banks lend money incomes and a great reduction in private exactly the same way as the Sovereignty loan – that they don’t necessarily have – into indebtedness. It was this creative use of the petition proposes. So I was just telling them, existence so that it is birthed with interest powers of the powers of the central bank and ‘Go back to what you did, before this “new incorporated into the price structure.” And the central government which made Canada right” stuff that got you into such trouble.’ then when this arrangement causes a rise in in a few years an industrial power, and ush- “The Canadian organization to support prices to pay for the interest incorporated ered in some 35 years of the greatest growth the plan could not be called Sovereignty for into the very money creation, the Bank of and employment levels in the history of capi- obvious reasons having to do with Quebec Canada has been pushing up interest rates talism, indeed of the history of the world. separatism. That’s a pity because Ontario’s still further to “lick inflation.” Those higher “As I see it, the governments of Canada own Mackenzie King said it all. ‘Without prices were due largely by the substitution of have broken three fundamental rules. These government creation of money, talk of sov- government created money that is spent into rules are: ereignty and democracy is futile.’ André existence without interest rates attached, “1. No sovereign government should chose the name Canadians for Constitu- and the huge increase of M3, which is part ever under any circumstances borrow any tional Money. of the money lent into existence thus incor- money from a private bank. “A sovereign government like Canada porating interest into costs and the price “2. No Canadian federal, provincial or reserves to itself the constitutional power to level. That in essence places speculative local government should borrow foreign create legal money. Indeed, only government bank capital in the driver’s seat and they go money when there’s excessive unemploy- of Canada is legal money or legal tender just on pushing up this interest creating formula ment here. as it says on any Bank of Canada note. That’s until it produces interest on interest two ever “3. Governments, like businesses, should the only legal tender money we have.” greater degree. Finally when the ever mount- distinguish between capital and current ex- ing process cannot continue, that leaves our penditures, and when it is prudent to do so, Bank Money a Mere Promise governments with only military solutions to finance capital improvements with money to Pay Cash get out of the hopeless financial corner into government has created for itself. “The bank money that is so much more which they have gotten themselves. “In the rest of the time I have, I’ll speak prevalent today is merely a promise to pay “I urge Ontario, the most powerful prov- mainly about the first point. Professor Wil- legal tender But we have a very top-heavy ince in Confederation, to demand the fed- liam Henry Pope will speak on the second situation now where there’s very little legal eral government exercise its constitutional point. Mr. William Krehm will do the same tender in the country, very little spendable powers and compel the Bank of Canada to for the third rule. M1, they call it. And we’re getting along create meaningful sums of money and lend 4 “Bad monetary policy and bad monetary with very high interest rates, very inefficient these sums at its wartime /10 of 1% to 1% institutions have caused the depression that money substitutes, ‘funny’ moneys, includ- to the provinces and local governments to now grips the world. But every crisis is also ing M2 and M3. pay for new infrastructure programs such as an opportunity. A most promising action “The Bank of Canada has all the powers Toronto’s new subway, etc., that we need to plan has been developed out of COMER’s in the Bank of Canada Act necessary to carry deal with our unemployed and with our in- deliberations. This is the Sovereignty loan out some Canadian version of the Sover- frastructure, educational and environmental petition to end the Depression created by eignty plan. I’ll skip over the well-known deficits. Mr. Ken Bohnsack of Freeport, Illinois. It passages of section 18 of the Act. “Mr. William Henry Pope: The notion reads as follows: ‘To promote the general “By wise use of its powers from the day it that Canada must borrow abroad to fi- welfare, we the people petition Congress opened its doors in 1935 through the end of nance the current account deficit is to get to make interest-free loans of United States the war in 1945, the Bank of Canada created it precisely backwards. Without a current Treasury money to tax-supported bodies for almost 80% of the new money needed to end account deficit (more Canadian dollars sup- voter-approved capital projects.’ the Depression and win the war in 1945. plied than demanded because of current ac- “Some 1,371 tax-supported bodies, plus “What a contrast with the most recent count transaction) the importers of capital the US Conference of Mayors, with 1,050 period. In 1945 Canada’s base money, or would be quite unable to effect their capital

 | Economic Reform October 2007 www.comer.org imports by turning their foreign currency the Ontario government’s capital projects into Canadian dollars. would be for the Bank of Canada to use “The way it works, I’ll explain. The in- article 18 of the Bank of Canada Act to lend BookStore flow of foreign money on capital account or to the Ontario government directly. That Available from COMER Publications our foreign borrowing – the $3 billion, the would not be ‘inflationary.’ but on the con- 245 Carlaw Avenue, Suite 107 government of Ontario borrowed abroad trary anti-inflationary, since it would keep Toronto, Ontario M4M 2S6 earlier this year – increases the demand interest out of the costs of the provinces Price plus $2.50 P&H or as indicated: for the Canadian dollar. Anything that in- projects and hence reduce the taxation as creases the demand for something pushes up well as interest rates entering price. More- Hazel Henderson its price and in proportion lowers the price over, by adopting accrual accountancy – also • Building a Win–Win World – Life of foreign currencies to Canadians. That is known as capital budgeting on top of that Beyond Global Warfare, $15 + $6 why Canadians wish to increase their im- the government would have several distinct • The United Nations: Policy and ports, and to do so exchange their Canadian factors keeping the price level lower. There Financing Alternatives: Innovative dollars for the now cheaper foreign curren- remains a detail, to note, however. Since the Proposals by Visionary Leaders, cies that came in on the capital account. provincial government is not a shareholder Editors Harlan Cleveland, Hazel Henderson, Inge Kaul, $10 + $3 Thus the capital account surplus causes the of the Bank of Canada, the interest paid to current account deficit. the Bank of Canada by the province to it W.F. Hixson “Nothing could be better for Canada would not return to it as dividends. It would • It’s Your Money, $10 than that foreigners should take out every go to the federal government instead. But William Krehm bloody cent they ever lent us and then the since under the present system, much of the • Towards a Non-Autistic Economy dollar would drop, and that’s the best thing growing fiscal problem can be traced to the – A Place at the Table for Society, that could happen to Canada. Of course, it federal government down-loading social and $20 + $6 would make it more costly to go abroad, and infrastructural problems to the problems, • Babel’s Tower: The Dynamics imports would increase in price, but that’s because it had blown its wad bailing out our of Economic Breakdown, $10 simply something that’s in the system. We’ve gaming banks for the second or third times • The Bank of Canada: A Power been so unproductive for so many years be- in as couple of decades, the province would Unto Itself, $5 cause of the high rate of interest, the sooner have a powerful case for negotiating an ar- • Democracies and Tyrannies of the the dollar drops the better.” rangement whereby the federal government Caribbean, second English and “Mr. William Krehm: The distinction would pass on the equivalent of the provin- third Spanish editions available, $15 + $3 between capital and current spending is cial government’s interest paid to the Bank • Meltdown: Money, Debt and ignored in the accountancy of the Ontario of Canada for its loans that reached it in its the Wealth of Nations (ed. by government and of the federal government dividend payment. This would introduce a W. Krehm) $25 + $5 and at least most of the other provinces. missing degree of harmony between all lev- • Price in a Mixed Economy – When any of these governments puts up or els of government, since the provinces have Our Record of Disaster, $15 + $3 buys a building, or acquires machinery that downloaded social programs to the munici- Kurt Loeb will last decades, it is written off entirely in palities just as the federal government did to • White Man’s Burden, $15 includ‑ the year of its acquisition and carried on the it, without the funds to take care of them. ing P&H government’s books thereafter at a token “But once you break the conspiracy of si- dollar. However, the debt contracted to pay lence about how we have been financing our James Gibb Stuart for the acquisition is carefully amortized governments’ capital projects at all levels, • Fantopia. “With much grace it more or less over the useful life of the asset you will have countless ways of arranging sets out as a parable the case for acquired. A whole line of auditors general our affairs more sensibly and economically. monetary reform. A dry-as-dust recommended that capital budgeting, also We did so during World War II, and we but terribly vital subject is trans‑ formed into a highly readable known as ‘accrual accountancy’ be adopted could do so today while underpinning peace tale” (W. Krehm), $8 + $2 by these governments. The United Nations and well-being in the world. Not the least of • Economics of the Green Renais- has made the same recommendation inter- these is introducing serious accountancy at sance, $3 + $2 nationally, but nothing has been done about all levels of government. I am talking about it. If you tried running a private corporation double-entry bookkeeping. Without it ac- combo offers: on that basis, it would be bankrupt from day countancy, and democracy itself, is a fraud. • Special Gibb Stuart Package: Fan- one. It couldn’t raise a dollar in capital. “It’s long been the practice of all Ontario topia and Economics of the Green “Professor Hotson has emphasized how governments, be they Tory, Liberal or NDP, Renaissance, $10 + $2.50 the war and the subsequent peace were won after a budget is brought down, to send • Meltdown plus either The Bank by the central bank making available to the a civil servant to Boston to explain to the of Canada or It’s Your Money, $35 + $3 government its money-creating powers. You bond-rating people that the deficit is really • Meltdown, Democracies (English will find all the provisions that made this not a deficit, because what has been written or Spanish), Price in a Mixed Econ- possible in the Bank of Canada Act, rather off as a current expense is a capital invest- omy, Babel’s Tower, The Bank of like a dinosaur’s tooth, remarkable for the ment that will last for decades. But why in Canada and Towards a Non-Autis- fact that it’s enormously big, but hasn’t been the name of the Lord should the people of tic Economy – A Place at the Table used for chewing anything for aeons. this province not be given the key informa- for Society, $90, postage included. “The fair and logical way of financing tion to the bond-rating folk in Boston?”n www.comer.org October 2007 Economic Reform |  Politics, Not Technology, Is the Main Problem in the Energy Crisis Within days of each other news on two ity: families that have controlled Brazil’s with gasoline due to a 51-cent tax on each diverse fronts in Brazil and Canada indicate sugar-cane wealth for decades and even cen- gallon. And both ADM and Cargill Inc. that solutions for our living in peace with turies. Many don’t want to sell; others are faced narrowing profits in their US opera- our environment are technologically pos- asking sky-high prices for operations riddled tions last year due to leaping corn prices – as sible. What is impeding progress to meet with problems. side effect of greater demand for corn from critical environmental deadlines are political “The standoff is preventing some big ethanol producers. and social barriers. foreign players from getting into Brazil’s “By contrast Brazil’s sugarcane ethanol One of these has to do with the produc- promising ethanol market through acqui- can comfortably compete with costly oil tion of ethanol which traps energy from sitions and forcing them to develop their – even if oil trades in the low $40s per bar- sunlight in plants and transforms it into own projects from scratch. Yet resistance rel range. ADM’s CEO Patricia Woertz says ethanol. In Brazil the sun is far warmer to outsiders could affect how quickly larger she believes Brazilian ethanol operations and sufficient land is available to grow the amounts of cheap Brazilian ethanol can be- would provide ‘an opportunity for profit- sugar cane at low enough labour costs, to gin flowing into the world’s auto fleet. Big able growth no matter what happens in the make the resulting ethanol available at costs companies which have better access to credit US market.’ Although a stiff US import tar- and in decisive quantities. There no matter and capital could help develop and modern- iff of more than 50 cents per gallon makes whether oil prices may be up and down, the ize Brazil’s ethanol industry.” Brazilian ethanol costly to import into the problem is entirely political. US, Brazilian ethanol could dominates oth- The Wall Street Journal (09/10, “Ethanol Brazil’s Heirloom Lands er markets in Asia or Europe.” Giants Struggle to Crack Brazil Market” by are Not Readily Bought Brazil simply has better access to the en- Antonio Regalado and Grace Fan) tells of “Archer Daniels Midland Company, ergy of the sun than most other parts of the the seemingly star-crossed Brazilian etha- the largest US ethanol producer, has been world. And that is certainly no small thing nol promise as a solution of the oil crisis shopping here for more than three years. both for Brazil and through it with the rest in vast global areas: “Ribeirao Preto, Brazil Global sugar traders such as Australia’s of our planet. – Nowadays plenty of investors want to and Germany’s Suedzucker. All have met “Analysts say that Brazil needs billions of talk to Cicero Jonqueiro Franco. Together with high prices and lengthy negotiations. dollars in investment to expand production with two sons and numerous cousins, he India’s largest sugar and ethanol maker, and the pipelines and other infrastructure controls a great deal of something the world Bajaj Hindusthan Ltd. announced plans a to become the world’s supplier of ethanol. wants: ethanol. year ago to spend $500 million to acquire There are roughly 210 companies run- “Mr. Jonqueira Franco, a founder of mills, but have struck out. The domestic ning 368 sugar and ethanol mills. The five Companhia Acucareira Vale de Rosario, a sugar and ethanol industry is informally largest players generated about 17% of the steam-belching mill that crunches sugar managed and highly fragmented, making country’s ethanol last year. cane into sugar and ethanol, has received it less than ideal for outside investment. “In the US, where ethanol is made from offers from several suitors. These include Often, millers don’t have reliable account- corn, any company can build a refinery a $775 million bid for his company from ing books, and are plagued by tax disputes and buy corn on the open market. But New York based commodities giant Bunge and debts. Slow court decisions accentuate because sugar cane’s heft makes it costly to Ltd., but Mr. Jonqueiro Franco, whose fam- the problems. transport, and its sucrose content degrades ily arrived in Brazil in the 1700s and still “Labour and environmental pitfalls also quickly, crops are always planted close to owns prime tracts of sugar cane land in Sao loom for outsiders. Most sugar cane is still the mills that process them. That makes Paolo state he says he’ll never sell. cut by hand – gruelling work that has en- it difficult to sidestep people like Mr. Jon- “Thanks to high oil prices and worries riched landowners for centuries, but could queira Franco, who owns 3,200 acres of over global warming, multinational compa- expose foreign owners to liabilities. Global prime plantation land. nies are straining to find ways into Brazil’s bank HSBC Holdings PLC got unwelcome “Sugar barons’ control over the ethanol booming market for biofuels – i.e., renew- publicity for loans it had made to Para Pas- industry could impede Brazil’s effort to cre- able fuels made from crops such as corn and torile Agricola SA, a mill in the state of Para ate a global market for ethanol. Japan, for sugar cane. The US and other countries that was raided by a government anti-slavery instance, has been in talks with Brazil since hope to substitute as much as 15% of do- task force earlier this year. 2001 to sign a long – term ethanol contract. mestic gasoline for ethanol over the next “Brazil’s mill-owners face some political But the Japanese officials have wavered, decade. With ample land, low production pressure not to sell. If foreigners or large expressing concerns whether Brazil’s sugar costs and ethanol production experience, companies gain leverage Brazilians stand to families can furnish steady supplies of etha- Brazil is viewed by many as the country best gain less from an ethanol boom. Despite the nol. In the 1980s, local producers chasing able to sate world demand. Commodities many hurdles, foreign biofuel companies high sugar prices created an ethanol short- giants, hedge funds, and energy companies such as ADM believe that getting into Bra- age that left Brazilian drivers of all-ethanol have descended here as potential investors. zil is still a must. US corn ethanol which is cars without fuel. Having large companies But these are colliding with an earthy real- less efficient to make, has been competitive focused largely on ethanol rather than sugar

10 | Economic Reform October 2007 www.comer.org could help prevent future supply shocks. became cheaper than gasoline. Ethanol is create new cane plantations, or ‘green fields’ “Brazil has been using ethanol since the also gaining followers because it contrib- far from Sao Paolo state where Brazil’s pow- 1970s when the government decided to utes less to global warming than gasoline. erful sugar cane families dominate. Investor support the fuel to lessen its dependence on While burning either fuel produces similar George Soros and Texas hedge fund HBK Mid-Eastern oil. Over the decades the vast amounts of carbon dioxide a greenhouse group are plowing more than one billion country has managed to gradually reduce gas, ethanol crops such as sugar-cane reab- dollars into such efforts, as is Brazilian Re- the cost of making the fuel, but gasoline was sorb the carbon dioxide when they are grown newable Energy Co., or Brenco, a start-up so cheap in the 1990s that the effort almost – something that has no equivalent in the case backed by US billionaire Ron Burkle and died. When oil prices began their steady of mineral oil. venture capitalist Vinod Khosi.” climb in 2002, however, sugar-cane ethanol “Some foreign investors have decided to W.K.

Disentangling a Knotted World

So impassioned and promoted has our published research claims. Dr. Joannidis from greed, increasingly scientific convic- drive become to understand the hidden said. A new claim about a research finding tion from partisan passion. As scientific secrets of our world, that we are increasingly is more likely to be false than true. findings become fodder for political policy coming to overlook the difference between “‘The hotter the field of research, the wars over matters from stem cell research to belief and certainty. Then all that remains is more likely its published findings should be global warming, even trivial errors and cor- to falsify the weights and measures in ways viewed skeptically,’ he determined. rections can have larger consequences. that transform narrow self interest into “Take the discovery that the risk of dis- “Still other researchers warn not to fear greater truths against the lingo and formali- ease may vary between men and women, all mistakes. Error is as part of science as ties of science and we are well embarked, to depending on their genes. Studies have discovery. It is the inevitable by-product our self-destruction. prominently reported such sex differences for the search for truth that must proceed This came to my mind on finding on for hypertension, schizophrenia, and multi- by trial and error. To root out mistakes, opposite columns of the Marketplace sec- ple sclerosis, as well as lung cancer and heart scientists rely on each other to be vigilant. tion of The Wall Street Journal’s that seem a attacks. In research published last month Even so findings are rarely checked by oth- desperate attempt to question two supposed in the Journal of the American Medical As- ers or independently replicated. Retractions, poles of certainty – our science and our in- sociation, Dr. Joannidis said his colleagues while more common, are still relatively surance industry. Surely that takes us a long analyzed and published the research claims infrequent. Findings that have been refuted way from questioning what President Bush concerning gender and genes. can linger on in the literature for years to may be presenting as gospel at any particular “Under closer scrutiny, almost none of be unwittingly cited by other researchers, moment. them held up. Only one was replicated.” compounding the errors. The first under the heading of “Most “Statistically speaking, society suffers “Stung by frauds in physics, biology and Science Studies Appear to be Tainted by from an excess of significance. medicine, research journals recently adopted Sloppy Analysis” brings troubling questions “Overeager researchers often tinker with more stringent safeguards to protect at least into the very temple. Let us refer to them the statistical variables of their analysis to against deliberate fabrication of data. But separately in turn: “Science Journal, ‘Most coax any meaningful insight from their it is hard to admit even honest error. Last Science Studies Appear to Be Tainted by data. In the US research if a $55-billion-a- month the Chinese government proposed a Sloppy Analysis’: We all make mistakes and, year enterprise that stakes its credibility on new law to allow scientists to admit failures if you believe medical scholar John Joan- the reliability of evidence and the work of without penalty. Next week, the first world nidis, scientists make more than their fair Dr. Joannidis strikes a raw nerve. In fact, his congress on research integrity convenes in share. By his calculations, most published 2005 essay “Why Most Published Research Lisbon. research findings are wrong. Findings Are False” remains the most down- “On average researchers submit about “Dr. Joannidis is an epidemiologist who loaded technical journal PloS Medicine has 12,000 papers annually just to the weekly studies research method at the University ever published. peer-reviewed journal Science. Last year, Joannina School of Medicine in Greece and “‘He has done systematic looks at the four papers in the publication were retract- Tufts University in Medford, Mass. In a published literature and empirically shown ed. A dozen others were corrected. series of influential analytical reports, he has us what we know deep inside our heart, said “No one actually knows how many incor- documented in thousand of peer-reviewed Mouin Khoury, director of the National Of- rect research reports remain unchallenged. research papers published every year there fice of Health Genomics at the US Center of “Earlier this year informatics expert Mu- may be more than meets the eye. These Disease Control and Prevention. ‘We need rat Cokol and his colleagues at Columbia flawed findings, for the most part, stem not to pay more attention to the replication of University sorted through 9.4 million re- from fraud or formal misconduct, but from published scientific results.’ search papers at the US National Library more mundane misbehaviour: miscalcula- “Every new fact discovered through ex- of Medicine published from 1950 through tion, poor study design, or self-serving data perimentation represent a foothold in the 2004 in 4,000 journals. By raw count just analysis. There is an increasing concern that unknown. In a wilderness of knowledge. 596 had been formally retracted, Dr. Cokol in modern research, false findings may be it can be difficult to distinguish error from reported. even the majority, or the vast majority of fraud, sloppiness from deception, eagerness “‘The correction isn’t the ultimate truth www.comer.org October 2007 Economic Reform | 11 either,’ said Prof. Kevles.” power and economic privilege. Here the universities or the media, are purged of any- Now, we would propose that the reader problem is not that the official model gets thing that challenges the model enthroned. step back several paces to compare this with roughed up unjustly by many who get pub- What we would give for such a sorting out the state of affairs in economic theory and lished, but no matter how long and how well of obvious error with what was proved cor- the economic faculties of the world’s uni- the suppressed views may have been proved rect and useful over decades of our history. versities, and the world’s libraries. There it correct, or highly useful to society, with a Cleo, Goddess of History, simply has had is not the difficulty of the subject that leads change of political power and a new eco- her eyes torn out and she wanders about to honest or careless error. What is at stake nomic coming into control, any challenge of distraught in complete darkness. is not an objective truth, but the political their economic model, in the libraries, in our W.K.

Gospel for Year One of RM (Risk Management)

Should our epoch be changed from A.D. “product” of our one super-power, while year. Morgan Stanley reckons the total value (Anno Domini) to RM (Risk Management) production of directly useful items for hu- of new CLOs more than doubled to $66.7 for Risk raised to a higher mystique? That man survival is being outsourced to Asia and billion in 2005 from $31.9 billion in 2004. would seem to be our new Lord from whom Latin America. “With demand so high, it is a sellers’ under the new doxology all the supreme re- Then comes the Evil One whispering market, and the interest rate that inves- ward and punishment are deemed to flow. into the ear of the man of faith: “Why in- tors are getting continues to fall. Right I would not trust myself as a perennial vestors are so confident the markets will be now, a medium-risk investor would get doubter with the exact formulation of the placid is a troubling puzzle. The optimism 1.7% percentage-point more than the go- new evangel. So I will go to the column seem misplaced. It is unclear when the Fed ing short-term rate, which is near historical “Long & Short” of Jesse Eisinger (The Wall will stop raising rates. And the bond market lows. But if investors think prices are stable, Street Journal, 22/3/06, “Intrepid Debt In- – where long-term rates have been incon- and therefore that such low returns are at vestors Turn Up Risk, But Much Hinges gruously lower than short-term rates – is least safe, they will feel secure in taking on Lasting Stability”): “Let no one claim forecasting an economic slowdown that few on even more risk. The result: people are that we were not forewarned – even by Wall believe is really coming. talking themselves into deals now that they Street’s own paper. “That suggests that debt-market are fac- wouldn’t talk themselves into a few years “Debt investors expect prices in the mar- ing a rocky road. Yet investors are becoming ago, market observers say. ket to be stable and returns to be meagre for more confident that prices will have fewer “The CLO structure magnifies the as far as the eye can see. sharp moves up or down than in the past. risk for certain investors: The holders of “So they are coming to a natural conclu- Merrill Lynch’s index for measuring expec- the most risky slice – the so-called equity sion: it is time to borrow more money and tations of bond-market volatility fell below tranche – are on the book for the big hit if make riskier bets. That type of thinking is its all-time lows at the end of February.” just a small portion of the underlying loans often dangerous. “The previous low was set in July 1998. goes bad. So the numbers of loans that go “Investors make these bets mainly through Two months after that bout of optimism the bad must stay low and predictable for the esoteric products designed by Wall Street “Long-Term Capital Management crisis hit investors in the riskiest slices to continue math whizzes to spread the risk of owning and the index – along with global financial making oodles of money. So who is hold- debt. Those products bundle bunches of markets – went hay-wire. These confident ing the riskiest tranches? It is mostly hedge loans and slice them up into less risky and investors could be making a mistake. Right funds. As smart, nimble investors, they are more-risky sections sold to investors. now, the consensus expects the Fed to stop the logical holders of the risk. However, this “The problem is that nobody knows just raising short-term rates soon, and that long- group is also the most aggressive and the how much the few investors who buy the term rates will rise – a return to normalcy. But most in need of continued short-term per- riskiest portions stand to lose if things go that probably conflicts with their expectation formance. How much underlying ‘leverage’ badly. These are folks who bet, say, $1 million that markets will remain stable, since big do they all really have? Nobody really knows and stand to gain $10 million – or lose $5 changes in interest rates are rarely smooth. because nobody keeps track.” million or so. Such highly leveraged bets are “Despite this, the mood is sanguine and That is where faith comes in to the point being taken in products that lack transpar- the esoteric market for complex debt prod- of renaming our epoch. ency. Nobody known how much is at risk in ucts is booming. There were 225 non-bank “The cocktail is equal parts low returns, the entire market if there is a big blow-up.” investors active in these esoteric markets more leverage and equal transparency. As I know you were wondering about the at the end of last year, up from 170 a year the Fed keeps raising rates, the markets matter – this is where the new faith comes earlier, says Steve Miller, who keeps the data surprisingly don’t seem to be worried about in. It is a faith not in the Lord but in a for Standard & Poor’s. Most of the newbies: the hangover.” “self-balancing market” that solves all prob- risk-loving hedge funds. They promised us miracles if we only cut lems if just left alone, unrestricted by gov- “Take a look at one section of this market: taxes for the very rich and slashed wages and ernments, tax-collectors or whatever. That bank loans to companies that are bundled employment at home to make this possible. “whatever” includes economic production. and sold in pieces that are ranked from least And come to realize it, the economy is actu- You will note that the slicing of debt, real risky to most. The growth of this collateral- ally walking on water! or hypothetical, is fast becoming the main ized-loan-obligation market exploded last W.K.

12 | Economic Reform October 2007 www.comer.org A Monarch Currency in Need of Crutches From a friend I have received the copy of American Union,’ he argued that the inno- is no suggestion the that the three-country chapter of a new book about to be published vation would not necessarily erode national currency unification was to an extent car- by WND Books, The Late Great USA – The sovereignty. He suggested printing the new ried out in the form of NAFTA in the early Coming Merger with Mexico and Canada by currency with the amero symbol on one side 1990s. The result: it almost brought down Jerome R. Corsi. The chapter in question is and the national emblems on the other.” the world monetary system. It had been entitled the “amero” which is the common If only that were enough to keep us out busily promoted by Washington telling the currency apparently to replace the three cur- of Washington’s world adventures, or be- Canadians that the Mexicans were falling rent currencies of these lands. yond the reached of the Federal Reserve’s at over themselves to enter the NAFTA ar- “However, rather than embrace ‘dollar- times ham-handed monetary inspirations! rangement; and told the Mexicans that the ization’ – the practice already occurring in “The amero, however, would have its Canadians were impatiently awaiting the many Latin American nations of adopting own value on foreign exchange markets, application of the proposal. That Mexico the US dollar as the country’s currency – after the three countries converted their entered such an arrangement can only be ex- globalist scholars argue that a new currency, currencies into the amero at rates that leave plained by the detail that Mexico is far more the amero, must be created. Even before unchanged each currency’s income, wealth, corrupt than Canada. So – even though it 2002, when the euro was finally adopted by and international competitiveness at the had an infinitely more unfortunate experi- a number of the European Union countries, time of the conversion.” ence with its Northern neighbour: the loss academics in the US and Canada were ac- of half its territory to it and several invasions tively discussing the need to create a North A Way of Ending Unemployment – it was the Mexicans who significantly American Monetary Union.” Among Economists went further than Canada. The Mexican It was not a faith that lived or died qui- That in itself would go far to create full governments even floated a bond issue – the etly. Originally it attracted both those of employment amongst economists and stat- tesobonos – that actually gave the holders the the left who are temperamentally drawn to isticians merely arguing what these reassur- option of eventually being paid in US dol- anything that can be presented as a lowering ing phrases might mean. lars even they may have bought the bonds the barriers between nation and nation. But That is not atypical of the propaganda with pesos. some second thoughts surfaced among some for a common currency of one sort or an- It amounted to shorting the peso and of these after a while as they recognized other between Canada and her southern bolstering the dollar in every such bond that there was more behind this initia- neighbour. A couple of years ago when the deal. And, of course, the border had become tive, than the hope for a more united and Bank of Montreal espoused a common cur- free for the movement of currencies. As a hence presumably a peaceful world. Even rency – it is involved in 9% of the banking result the peso fell in value by some 40%. the rightist Fraser Institute in Canada which in the Chicago district alone – its lady chief And that so alarmed Washington with its was in the driver’s seat in most rightist initia- economist explained to an audience of “fa- repercussions throughout the world, that tives retired after a while from its position voured clients” the advantages of a common President Clinton without even waiting for for a common currency with the US. But currency as seen from her lofty post: “It has Congress’s approval organized the greatest whether because such a position was not made it so much easier the payment of her standby fund to that date – $51 billion US injurious to academic careers or due to a son’s bills at the school that he is attending – the US putting up $51 billion, the IMF sheer ignorance of Canadian and American in Europe.” the same amount and Canada, $1 billion. history, the united currency movement has Building walls between the US and its Even so there was a delayed echo of the persisted, giving ample suggestion of being prospective partner to the south, and pos- disaster of this close harbinger of the united amply funded. sibly – who knows – putting walls or at least currency goal in the East Asian crisis and A new development has been the ap- passports between Americans and those the Russian debt default a few years later. pearance of a decidedly rightist movement neighbours to their north is not invariably To this day Mexico has not recovered from in the US in opposition to it, of which the endearing to the idea of Canadians becom- partial currency unification experience. It Corsi book – of which we have seen only a ing absorbed in the cultural, monetary and contributed richly to the flock of Mexi- single chapter – is an outstanding sample. It military entanglements in a world that is can immigrants, legal and illegal into the gives a thumb-sketch of both an American increasingly turning to ultimate military US, for hunger makes no distinction. And and a Canadian leader in the pro-Amero solutions. US employers apparently up to now have movement. There is nothing, of course, against tem- needed both. “Economist Herbert G. Grubel of the porary cooperation with democratically And the wall that the US is building on Simon Fraser Institute in Vancouver coined rightist groups where the immediate goals its southern border provides the balance the term ‘amero’ and has led economic happen to coincide with yours, but this sheet of the partial experiments towards a thinking about the advantages of a unified warning is ever in place. Our goals have common currency. To grope its way back to North American currency. He was a Reform their roots deeply embodied in history. a serious peace, the world needs its history Party member of Parliament in Ottawa for Most other groups – particularly rightist to guide it about what has never worked and Capilano-Howe Sound from 1993-7. In a ones – tend to deal with twigs on the spread- cannot work. In Canada we need to apply 1999 paper entitled ‘The Case for the Am- ing tree of causes. For example, in the chap- the provisions of the Bank of Canada Act, ero: The Economics and Politics of a North ter of the Corsi book that I have seen there for years entirely disregarded and violated www.comer.org October 2007 Economic Reform | 13 by the government and our central bank. by mismanagement of the US economy by is a serious problem. Similarly, Medicare li- Without that history made accessible to presidents and congresses over decades, both abilities are intensifying as the government Parliament, our universities and our media Democrats and Republicans alike. adds new programs for the prescription civilization, as we have known it, has scant “Our federal budget deficits reflects drugs program.” chance of survival. decades of passing orderly generous en- The author would have been advised to And the final wisdom with the slightest titlement programs, beginning with the have studied the deregulation of the banks familiarity of the economic and monetary formation of the Social Security Admin- that had severely confined them to banking history of these countries by now too stale istration by Franklin D. Roosevelt during under the Roosevelt banking legislation, to occupy any serious student of the his- the Depression of the 1930s. Now with the and specifically barred them from acquir- tory of this land: “A US dollar collapse, if baby boomers retiring and with a US birth ing interests in the “non-banking pillars”: and when it occurs, will have been caused rate, finding future Social Security liabilities the stock market brokerages, insurance and real estate mortgage companies. For the repeal of this legislation beginning with the 1970s gave them increasing access to just Climbing the Derivative Ladder such other financial sectors. With that the cash reserves needed for the other “financial As the world grows ever more resistant to was shifted to the counter where shoppers pillars” own businesses were taken over by the policies imposed on it from a few com- bought the merchandise. And here the value the banks and used as cash base to which to mand centers, the distinction between fact of the goods was seen as determined entirely apply the bank multiplier. and fiction is rapidly disappearing. Policies by the balance of supply and demand – if Bailing out the banks from their losses as are being shaped less by their feasibility in demand outstripped supply, prices rose. If a result of their takeover of the Savings and handling society’s problems than by whether supply outstripped demand, it sank. What Loans in the 1980s led to the government they serve the rate of expansion predeter- you may ask would determine the level of absorbing losses of some $200 billion. By mined by the replacement of growth rates – the constant remainder? The mathematical 1988 the Bank for International Settlements i.e., of “derivatives of higher degrees” rather process of integration: by adding a constant based in Switzerland, which served as a semi- than by the actual first-degree tables that are number whenever performing the math- underground centre where the world bank the basis of bookkeeping. To come up with ematical process for determining the new come-back to its 1929 freedom and glories, growth rates, however, one must cast one’s market price balancing supply and demand found it necessary to bring in its Risk-Based nets into the inscrutable future. History remains constant That constant, as indicated Bank Capital Requirements that declared alone won’t do. Hence it is the growth rates, by the name, is not changed by bargaining the debt of developed countries “risk free” and the rate of growth of the rate growth of between suppliers and demanders. Signifi- and hence requiring no down payment for the actual production, and so on to infinity cantly there was no curiosity among any of banks to acquire. At the same time the BIS that come to rule economists’ reasoning. the three different marginal utility theories and the central bankers it dealt with had That widens the gap between reality and of value that arose quite independently in overlooked a crucial detail: when the banks the empowered fictions being reared. three different countries at virtually the load up with bonds entirely on credit and The origins of the current acrobatics same time – Britain, France, and Austria. interest rates go up the market value of such with derivatives is clear. It came into fashion But marginal utility value theory was debt hoards drops steeply. That is precisely in price theory, hardly by accident shortly baby stuff – it dealt only with the rate of what happened in 1934 to the $80 billion of after the Paris Commune (1871) when growth or the first-degree derivatives. Basi- debts held by Canada’s banks – quadrupled the labour theory of value (used by David cally it expressed the political dominance since 1990. This matched throughout much Ricardo and Karl Marx) took the value of of the industrial capitalist. But with the of the world, threatened to bring down the goods in a capitalist society to depend on triumph of the financial sector of capitalism, international monetary system. the amount of average labour needed for the the evaluation of worth of shares, bonds, The largest safety backup was organized commodity’s production. Or, alternatively, corporations, and the world was done in by the US, the IMF and Canada. Finally by the cost-of-production theory (John terms not of ordinary commodity prices, Washington realized that the days of sky-high Stuart Mill). but in terms the rates of interest with which interest rates were over. To get around that Both of these located the site of value cre- the drover – essentially the deregulated the US which had been writing of its physi- ation in the workshop, the “Satanic Mills” bankers – whipped the productive herds cal capital investments – bridges, buildings of the raw industrial revolution. that included the industrialists into profit- roads, equipment while careful amortizing That was all right in the days of Ricardo able obedience. Society thus ascended a the debt incurred to build or acquire them when most English workers were still illiter- further step on the derivative ladder. finally brought in accrual accountancy, i.e., ate. But mechanics’ institutes soon arose to This required the cleansing of our uni- began amortizing a them as the private sec- teach workers to read, and what had been versities of everything that had been learned tor had done from time immemorial over over their heads could soon be read by more in the Depression of the Thirties, including their likely useful life. Though that was dis- of them to convey a dangerous angle of vi- that the banks had to be prevented from tak- guised as in the Department of Commerce sion. Hence, the years after the bloody Paris ing over the other “financial pillars” – stock statistics as “savings,” that was no adequate Commune hailed by Marx from London brokers and insurance and real estate. For description of them since savings implies as the precursor of proletarian revolution that we refer you to the article beginning on cash or assets readily convertible into cash created the need for a new observation post page 13 of this issue. – these assets were buildings, roads bridges, for economic theory. From the workshop it W.K. bricks, mortar steel, and equipment. It was

14 | Economic Reform October 2007 www.comer.org enough to turn some 1.3 trillion dollars to surface. new technologies and the education of the of assets of the federal government, which The weakness of the Corsi chapter is younger population to education standards produced the positive balances that brought indicated by his having to go back to leg- undreamt of before the war. It is the trillions down interest rates, and created the plethora islation of the Roosevelt era that with its lavished on bank bailouts as they lost more of cash that along with deregulation of the sequel gave the world surcease from the and more of their capital and were bailed banks allowed them gamble their heads off prewar depression, financed the renovation out at the expense of the most defenceless and bring on the present subprime mort- of infrastructures of 16 years of depres- members of society. gage problem others that are just beginning sion and war, allowed the introduction of William Krehm

The Detail Governor Dodge Forgot

The Globe and Mail (15/10, “‘We should tem when Washington conned Mexico and in 1933, faced with 38% of the banks in have been driving rates harder,’ Dodge says Canada into NAFTA. Mexican politicians, the land closing their doors, declared a of Credit Crunch”) carries a small but as- considerably more corrupt than some of bank moratorium and extended it when it tounding article from Reuters News Agency: our own, not only removed the established ran out. And then he passed new banking “Bank of Canada Governor David Dodge restrictions on foreign currency leaving the legislation that prevented the banks from said he should have driven up interest rates country, but issued special bonds – the so- acquiring interests in those other “financial ‘harder’ before the current credit squeeze called tesobonos – that could be bought for pillars.” The reason was that when banks to tighten borrowing conditions, according pesos but gave the buyer the option of hav- get their hands on the liquidity reserves to an interview published in The Economist ing them repaid in US dollars when due. In that those other “financial pillars” keep for magazine. essence to please the Yanks Mexican govern- the needs of their own businesses they use “In a mea culpa to financial markets, ment sold their own currency short. What a them as money base for applying the “bank he said the central bank may have played a tip off for currency speculators! Meanwhile multiplier.” The latter is the very essence of role in fomenting excesses in credit markets the frontier had been opened wide as far as banking, the banks’ ability to lend out far prior to the disruption rising from defaults foreign currency was concerned. As a result more than the cash they hold. on payments by US subprime mortgage the Mexican economy collapsed with the So long s they can honour all claims on holders. peso losing some 40% of its value. Foreign the money left with them, all goes well. “In an interview published on the mag- currency was sent abroad in torrents by Should they fall down, however, in honour- azine’s website he said, ‘One can see in those with advance information of the ar- ing the claim of a single client, a run on retrospect that we should have been driving rangement. the entire banking system is likely to ensue. these rates harder than we did because in That was a principal factor in bringing on reality credit conditions were being eased by Mexico’s Epic Nationalism Sold Short the crisis of the 1930s. That is why the Roos- increased securitization and movement of The Mexican banks which had been evelt Banking Laws that were shortly after stuff off balance [sheets].’ privatized not long before after a period of brought in along with insurance for bank “Mr. Dodge was also outspoken in an in- nationalization during which the govern- deposits, explicity forbade banks stepping terview with The Financial Times of London ment got them out of their debt, had to be outside banking and taking over the other yesterday. ‘The European Central Bank’s nationalized all over again. Eventually, 85% “financial pillars.” However, after the war efforts to restore confidence to markets of them ended up under foreign control. and years of keeping the nose of the banks by pumping in liquidity are unlikely to The standard of living in Mexico collapsed, strictly to banking in the US and through- succeed,’ he said. ‘I’m not sure practically, and a new financial group of stock brokers out the Western world, the banks prospered whether it would do anything. If I thought replaced the banks even in marketing gov- once more and started yearning for the old that somehow there was a magic wand and ernment bond issues by TV auctions. It is fleshpots of the 1920s. And because of that, we did that for three or four days, and that largely because of that experience that the beginning in the latter 1960s in a serious all of a sudden the markets would clear, and armies of unemployed began crossing the way the US banks were deregulated and life would be beautiful.... There is no prin- American frontier with and without visas. globalized. In the 1980s they took over the ciple that says that is a bad thing to do. but The Mexican financial crisis, moreover, Savings and Loans in the US – essentially I can’t believe that it will do the job.’ threatened to spread abroad and bring down mortgage associations – and soon ended up “Mr. Dodge also criticized credit rat- the world monetary system. subdividing land for housing in the Arizona ing agencies who gave top credit ratings to There was a further factor in this crisis of desert. Eventually the Government took highly structured products without explain- which no Governor of a central bank can be over many of them paid out their bad debts ing all the attendant risks. ‘I won’t let the unaware. The great Depression of the 1930s and sold them at an almost quarter billion credit rating agencies totally off the hook. had been brought on by the Wall Street dollar loss to healthier banks. They didn’t work terribly hard to make sure crash of 1929. And that had happened That, however, only made the govern- people understood their ideas,’ he said.” because the banks had been permitted to ac- ment an accomplice of the banks in their The most gentle remark in response quire control of the other “financial pillars” push for picking up the trail as of 1929 to the Governor’s wisdom, is that he, too, – stock brokerages, insurance and mortgage when they had brought down the entire has not overworked learning about what companies. That is why President Franklin economy for a decade until the World War. happened to the international financial sys- Roosevelt when he was first inaugurated Coming to the rescue of the world banks www.comer.org October 2007 Economic Reform | 15 as well, was the Bank for International ments that declared the debt of developed able to acquire entirely on the cuff – no Settlement, (BIS) a sort of central bank- countries “risk free” and hence requiring no money down. ers’ club based in Switzerland. To help the down payment for banks to acquire. In this American and world banks out of their and other such ways the banks were allowed The BIS as Low-profile War Room for non-banking losses, BIS in 1988 brought to replace their lost capital by clipping the Banks’ International Comeback in its Risk-based Bank Capital Require- coupons of the massive bonds they were Now the key detail of this hushed-up tale. When a central bank holds govern- ment debt, whether the central bank is Globalization’s Poisonous privately owned or nationalized as the Bank of Canada was, the interest paid on those bonds comes back – substantially – to the Gas Balloon government as dividends. In the case of At both the US and Chinese ends of the to the US have fallen 25% since 1995, part- privately owned central banks like the US phenomenon the warnings go on mount- ly due to the downward pressure brought Federal Reserve System, the justification ing. by discount retail chains. One way Chinese of those remittances of the Fed’s profits to The Wall Street Journal (22/8, “China factories have kept costs down is by dump- the government is, historically, the ancestral Pays Steep Price as Textile Exports Boom” ing waste water directly into rivers. Treating sovereign’s monopoly in coining and recoin- by Jane Spencer) reports: Dongguan, China contaminated water costs upwards of about ing with less metal content nation’s money. – Last summer Chinese government in- 13 cents a metric ton, so large factories save Since 1971 the world has gone off the gold vestigators crawled through a hole in the hundreds of thousands of dollars a year standard and there is nothing other than concrete wall that surrounds the Fuan Tex- sending waste water into rivers in violation government credit behind the paper bills tiles mill in southern China in a surprise of China’s water-pollution laws. and the bookkeeping entries of the central inspection of the plant. What they found “‘Prices in the US are artificially low,’ bank. For these are the only legal tender. It caused alarm at dozens American retailers, says Andy Xie, former chief economist for must be accepted by law in payment of any including Wal-Mart Stores Inc., Land’s End Morgan Stanley, Asia, who now works in- debt over some trifling amount otherwise Inc., and Nike Inc. that use the company’s dependently. ‘You’re not paying the costs the debt is no longer valid. No banker, and fabric in their clothes. of pollution. And that is why China is an certainly no central banker could possibly “Villagers have complained that the fac- environmental catastrophe. That is one be unacquainted with this stretch of our tory, majority-owned by Hong Kong-based reason why many of the country’s biggest banking history. However, it is not consid- Fountain Set Holdings Ltd. had turned their rivers resemble open sewers and 300 million ered fit to be shared with the public that has river-water dark-red. Authorities discovered people lack clean drinking water. Now. US paid the immense cost of what was not only a pipe buried beneath the factory floor that retailers are scrambling to prevent environ- a bank bail-out but of further deregulation was dumping roughly 22,000 tons of water mental issues from creating the same sort which would involve an enhancement of contaminated from its dyeing operations of consumer backlash as the anti-sweatshop the ability of our banks to gamble bigger if each day into a nearby river, according to campaigns of the past decade. not better. local environmental officials. “‘After labor issues, the environment is In Canada the federal government debt “In the two decades since US companies the new frontier,’ says Daryle Brown, vice- between 1988 and 1992, had risen from began turning to Chinese factories to churn president for ethics and compliance at Liz some $20 billion to $80 billion. And at out cheap T-shirts, jeans and sneakers that Clairborne Inc. which uses Fountain Set the same time the Bank for International millions of Americans wear daily, China’s air, cotton in some of its products. ‘We certainly Settlements had urged the central banks land and water have paid a heavy price.” don’t want to be associated with a company throughout the world to push interest rates The clouds of smog that comes from that’s polluting the waters.’ to the skies, to achieve what they chose to the Pacific to blanket Los Angeles have “The textile industry is one of China’s call “zero inflation.” received no lack of attention from the US dirtiest. In addition to heavy metals and And here is what Governor Dodge com- press. What has not reached the American various carcinogens, fabric dyes may con- pletely forgot in his expressing his regrets for public so soon or steadily, is that in a very tain high levels of organic materials, and not having pushed interest rates higher. He relevant sense it is just coming home. For thread is often dipped in starch before it is simply didn’t dare to. For the government without the Globalization and Deregula- woven into fabric. The breakdown of large bonds that the banks had loaded up with tion push out of the US, it could never have amounts of organic compounds such as to replace their capital lost in their gambles, happened. starch can suck all the oxygen out of a river, would have come crashing as soon as inter- “China has faced harsh criticism in re- killing fish and turning the water into a est rates ere pushed much higher. For with cent months over the safety of exports rang- stagnant sludge. new bonds sold at par, the older ones with ing from tainted tooth-paste to toxic toys. “Fountain Set’s 230-acre Dongguan Fuan a higher coupon would tumble in market But environmental activists and the Chinese Textiles factory campus here sends a huge price. The banks would, as a result, be at government are increasingly pointing to volume of textile fabric to American closets. risk again. the flip side: the role multinational compa- The company is the largest knit manufac- And that resulted in a positive innova- nies play in China’s growing pollution by turer in the world, and its factories are re- tion that no central bank head should not demanding ever lower prices for Chinese sponsible for about 6% of the global supply be allowed to forget. Up to that point no products. of knit cotton, according to Eddie Lau, an government – with the temporary excep- “Prices on fabric and clothing imported analyst at City Inc. in Hong Kong.”n tion of Denmark and Sweden, when it

16 | Economic Reform October 2007 www.comer.org made an investment, that would last even sels where these are held – health, and social wide of the mark he and his co-workers for many decades, treated it no differ- services as the most productive investments had been in exaggerating what the delay ently than the soap in the wash-rooms of its that a government could make. He reached would be. He attributed this to their having buildings. It wrote it off in a single year and that conclusion because two decades before concentrated on physical destruction, while in year two recorded their existence only he and many hundreds of young econo- ignoring that their exceptionally educated by assigning the value of $1 on the assets mists who had been sent by Washington to and skilled labour force had come out of the side of the government ledger to inform its Germany and Japan to predict how long it war intact. auditors it had simply forgotten about the would be before those two defeated powers It is amazing how much vital informa- investment. But on the debit side the debt would be able to reconstruct their countries tion about the world, its economy, its mon- incurred to pay for the investment was care- to have them reappear as formidable com- etary and political systems, that Governor fully amortized over decades, which would petitors on world markets. Two decades Dodge can avoid. more or less correspond to the natural use- later Schultz wrote that it was amazing how William Krehm fulness of the asset. That had a series of un- helpful results: such accountancy breached the principal of double-entry bookkeeping, The Great Inflation Mystery and led to far more taxation being collected than accountancy would require. That was not “inflation,” which was used as a pre- Still Unsolved text for raising interest rates, but simply In a special section of its 23/09 issue your theoretical harp care of that is “sys- bad bookkeeping that could land a private headed “Soapbox” – certainly a sign of the tems theory.” This, borrowed from science business executive in jail for tax evasion. times – under the heading “The Great Infla- and engineering, identifies the subsystems Here it was the taxpayers and consumers in tion Mystery, Still Unsolved by Lawyer, Ac- within a system that must be kept in good general who were being deprived in order to tor, Writer and Economist,” The New York functioning order if the system as a whole is replenish the banks’ gambling funds. That Times tries shedding light into the general to function. As in an automobile in which in turn left a deficit that was not necessarily darkness. all the subsystems such as brakes, engine, there, a powerful pretext for slashing social My first point: economics is an extremely electrical, electronic subsystems, transmis- programs. inexact science. The more economists try sion, engine must be kept in good function- And now that President Clinton realized to doctor it up with formulas, the clearer ing order. Averaging out their efficiency to that this could not go on without bankrupt- it is that the more we try doctoring it up a happy result is not a solution – they must ing the entire world financial system, he with formulas, the clearer it is that we know all individual be in good order, if the car is brought in what his auditors – as had those very little about what causes great economic to budge without being a menace to human of Canada and a Royal Commission two de- events. In particular we do not know what life. That concept when I was introduced to cades earlier had been urging for years, to no causes inflation. it was being seriously considered in many avail. But Clinton was too keen a politico to “For a while we thought it was ‘cost universities, under the leadership of Jay antagonize the folks who can contribute so push’.... Then we thought it was ‘demand Forrester, Dennis L. Meadows and others. generously to election financing – the bank- push’ – i.e., no aggregate cost increases of Courses were given in economics faculties. ers. So when the immense job of redoing certain goods and services but demand push No longer, the very concept of multiple, the books was done and the process carried exceeding by far available supply.” different factors that can be involved in back to 1959, and some 1.3 trillion dollars But Mr. Stein misses another possibil- higher prices. Some may be controlled, oth- of assets discovered, they were called in the ity – the price level can go up not for any ers should be recognized as investment in Secretary of Commerce’s figures beginning single reason but by a variety of causes, material and human public capital. What with January, 1996, “Savings” instead of not all of them pathological. It could. for has happened to the economics profession is “Physical Assets.” example, be mainly due to our attempt to that it has allowed its wits to be highjacked “Savings,” however, is used by econo- improve our social accountancy, and hav- by those who live by interest-rates and a mists to refer to highly liquid assets – legal ing begun spending more of our tax-dollars monopoly position for it as what has been tender or cash, or financial assets of the on restoring the damage we have done to called the “dominant revenue” whose vol- highest quality readily convertible into cash. the environment, and treating that as fiscal ume and monopolist powers are taken to be And here we are talking about buildings prudence rather than fiscal irresponsibility. a reliable index of the society’s well being. that may be a half century old with the Or it could be due to our society having be- Thirty years ago, before COMER was site beneath going on ever appreciating, or come far more urbanized than it had been, founded I wrote a booklet Babel’s Tower: The bridges, highways. and with large cities a host of services like Dynamics of Economic Breakdown that is still subways, schools, libraries are needed. Ditto in good supply. It lends itself to the devel- Governor Dodge’s Master Gaffe the new standards of education needed to opment of all sorts of simple and effective Nor is that the end for Governor Dodge’s serve the new technologies that have taken policy techniques explained in the booklet. incredible gaffe. In the 1960s an econo- over. In order to satisfy that need more That is the approach that has disappeared mist on the University of Chicago staff was public spending is necessary to pay for new even from the horizon of critics like those to awarded the so-called Nobel Prize for Eco- post-secondary training and education. If which The New York Times is so generously nomics of the Bank of Sweden for his paper you don’t address that you are guilty of fiscal devoting space. That indicates the amount recognizing investment in human capital – neglect rather than prudence. of damage done by the take over of our eco- education, skills, and hence care of the ves- Another important string you need on nomics curricula throughout the university www.comer.org October 2007 Economic Reform | 17 world by the “self-balancing market” model ing was arranged and in year two listed the economics curricula in our universities. We asset value at a token one dollar. Naturally have been shorn of the knowledge of our Allen Good’s cartoons this had some drastic effects on the “fiscal history and what the lessons learned for will return. performance.” It led to the attempt collect it and applied so fruitfully in the first few more taxation than was necessary, and that postwar decades. extra hump of taxation on price created the ment of Mexico yet again, ended up 85% illusion of more inflation than existed. It Getting Close to the Source in foreign hands where they remain to this also created the false semblance of a budget- of the Trouble day. That was a bitter pill for the pioneer of ary deficit that was not necessarily there. However, Mr. Stein in parts of his article nationalism in Latin America to swallow. Meanwhile any debt incurred for the acqui- is getting close to the source of the trouble. But then Mexico and its nationalism had sition of the given capital asset. He writes: “The plain truth, as I para- been put through the ringer. The revised bookkeeping, worked back phrase my sainted father for the millionth Under the North American Free Trade to the year 1959, first appeared in the De- time, is that we simply do not know how Treaty that they had been conned into en- partment of Commerce figures beginning the various parts of the monetary machine tering because Washington assured them with January 1996, that showed an in- work on the economy. (We don’t seem to Canada desired so badly, at the same time creased item under “Savings” of well over know much about how the fiscal parts work, that it assured Canadians that it was the $1.3 trillion. This it was not, since the term either. Anyone who would have guessed that Mexicans who were the ardent suitors in “savings” is usually reserved by economists we would have run federal budget deficits the situation, the Mexicans had actually to refer to cash reserves or in short term, top the size of these since 2001 without major shorted their own currency by issuing teso- quality short-term reserves that can readily inflation would have failed any basic mac- bonos – that gave the owners the option of be converted into cash. However, that kept roeconomics final examination in 1966. It redemption in US dollars even they had interest rates low to give Clinton a second simply was not part of any economic system purchased them in pesos. In effect it was a term, the world its spell of low interest rates we knew about. In some way, this may this case of Mexico shorting its own currency. that led to the high tech stock boom. may have had some validity in an area I am This practically collapsed the Mexican cur- There remains a further major clean-up generally skeptical about: ‘supply side’ or rency with a flight of capital by those who job to be done on government accountancy. ‘voodoo economics.’)” had advance knowledge of what was in store In the 1960s Theodore Schultz had been Mr. Stein should apply the basic con- to send their money abroad. So shattering awarded the Bank of Sweden Nobel Prize cepts of systems theory to distinguish what was the effect that it contribued to mass for Economics, for his work that resulted may be or may not be what he chooses to migration of workers, legal and illegal into in the recognition of investment in human call “voodoo economics.” What he should the US that led to the present wall-building capital – education and skills and hence in realize is that no verifiable part of our his- exercise by the US on its southern border, health, and social services that protect the tory should be dismissed not even with a that is hardly the most attractive aspect of vessels that hold this precious investment. similar acknowledgment. In 1988, to bail Panamericanism. Schultz reached that conclusion because of out the US banks from their heavy losses in So drastic was the Mexican economic the vast error that he and hundreds of other taking over the Savings and Loans real estate collapse, that it threatened to bring down young economists had made when they had firms, the Bank for International Settle- the world monetary structure. And on the been sent by Washington to Germany and ments (BIS) brought in its Risk-Based Bank initiative of President Clinton a $51 billion Japan to predict how long it would be before Capital Requirements. This declared the standby fund was arranged with the US, those two powers would be able to reap- debt of central governments in developed the IMF and Canada putting up the largest pear as formidable competitors on world countries “risk-free.” and hence needing no standby facility to that date. markets. Twenty some years later Schultz down payment for banks to acquire. As a concluded that he and his colleagues had result banks loaded up with gobs and gobs What Really Gave the World a Period been so wide of the mark because they had of the stuff, and clipped the coupons to re- of Low Interest Rates concentrated on the physical destruction place their disappeared revenue. In Canada But another more benign effect of this and overlooked that he high education and the banks holding of central Canadian debt whole sordid chapter was that it convinced skills of the working population had come quadrupled approximately to $80 billion Washington that the days of sky-high inter- through the war essentially intact. Hence Canadian dollars. At the same time the BIS est rates were over in view of the govern- his conclusion that investment in human pushed interest rates into the skies “to attain ment bond hoards that the private banks in human capital is the most profitable zero inflation.” In their eagerness to bail internationally had accumulated to replace investment a country can make. Today that out the banks from their huge losses, they their lost capital. important conclusion has been forgotten – and the central bankers gathered around So to arrange that the US government again along with the once celebrated name them – overlooked a detail: when you push brought in accrual accountancy that the of Theodore Schultz. u interest rates, the market value of pre- US government along with just about every All this should help convince Mr. Stein existent bond hoards with lower coupons other government in the capitalist world had of the importance of systems theory in help- plunges. That is what happened to such an resisted bringing in. Instead what govern- ing him in his investigations. My congratu- extent that the Mexican peso lost some 40% ment used was known as “cash accountan- lations to both The New York Times and to of its value, and not only did the Mexican cy” – when a government built or acquired him for their effort. May you pursue it to its banks have to be nationalized once again, a building, a bridge, a road, it wrote off the logical conclusion. but eventually, made whole by the govern- entire spending in the year when the financ- William Krehm

18 | Economic Reform October 2007 www.comer.org The Ever Thinner Narrower Newspage In the olden days you had at least to cross You need only turn to the other side of There is clearly a logical breach in the the street to get a view of the two sides of a the same newspaper page to get hit in the reasoning or even a suggestion of a split vital problem. That is no longer the case. In a eye with the answer. personality in an eminence in the govern- recent The Globe and Mail (09/17), page one ment that Mr. Flaherty undoubtedly is. His carries an article headed “Use soaring loonie Our Neglected Human Investment concern for using our high looney to get to go high tech, Flaherty says,” by Sara Per- “Mad over prices, students refuse to go a higher technology by giving employers kins that enlightens us: “As the loonie hits a buy the book” by Roy MacGregor, under a a tax holiday. However, he is undisturbed 30-year high, the federal Finance Minister Peterborough, Ontario, dateline: “The sign, not only by the explosion of post-second- is calling on the beleaguered manufactur- at first surprising is soon understandable: ary education costs but by the abuses in the ing sector to compete with other countries ‘Know the Daily Limit on Your Debit or pricing of textbooks. Unless our govern- by boosting investment in high technology Credit Card Before you come to the Cash.’ ment wades in with the same fervour to as- rather than relying on cheap labour. “The printed sign stands before the sure this country of a continued and indeed “Canadians with plans to go shopping or checkout at the Trent University bookstore. expanded supply of engineers and scientists, travelling south of the border are cheering As one student leaves, one from the long a lot of the glittering new equipment that the news that the dollar topped 97 cents US line that snakes far down the corridor is al- corporations will have acquired with the last week after gaining 14% this year, be- lowed to enter. They groan, coming and go- savings from the two year tax holiday or its cause it makes it cheaper to buy goods priced ing. ‘Here goes another 125 bucks,’ a young contemplated extension will be wasted. As- in US dollars. But for manufacturers and ex- woman says as she checks her backpack at tounding that the connection should have porters of everything from food packages to the entrance. escaped our minority government. In this it cars, the higher Canadian dollar makes their “‘Jesus!,’ a young man says as he flips over shows the insensitivity of a government with exports less competitive, meaning more pain a ‘used’ book on organic chemistry: $113.50. a 105% backing in Parliament. for the struggling sector that depends on There is a sense of conspiracy that cannot be Are the technologies contemplated per- selling its products to Americans. proved, a sense of helplessness. No wonder haps so advanced that they will require no “‘Some economists are predicting the they make them park their backpacks at the correspondingly skilled engineers, scientists dollar’s rise will dampen Canada’s hot econ- door – just check the stacks: Principles of and mechanics to look after and improve omy, as Canadian products become more Instrumental Analysis – $154; Essentials of upon? Or is it just that social prejudices die expensive in the US, which is in the grips of Genetics – $125; Fourth Canadian edition slowly, and the thinking of Finance Minis- a slowdown. If the manufacturing industry of Organizational Behaviour, used, $87. ter Flaherty and his cabinet colleagues has is to succeed, it must become more produc- Some of the titles even seem slightly ironic: not advanced so far from that of cabinet tive and more technologically sophisticated,’ Financial Accounting: A Critical Approach to ministers in Britain during the industrial Mr. Flaherty said. Developing Markets, a soft-cover: $131.35. revolution, when machines were brought “The higher dollar means that technolo- “The reason so many of the stacked in to increase the social distance and the gy imports that might enhance productivity books are tagged ‘used’ and seem in good contrast in rewards rather than bring them are now much cheaper for Canadian manu- shape is that many of them have hardly closer together? facturers. In addition to that advantage, the been opened and often are barely referred to On page 5 of this issue, I recount how Finance Minister hinted the government is by teachers and professors who stamp “Re- Theodore Schultz was awarded the Swedish considering extending a two-year tax break quired” over the stacks of texts. It is a serious Bank prize for his paper establishing, on for manufacturers who buy new machinery. issue and not just Canadian. the basis of their surprisingly rapid recovery He calls the move, which currently expires “According to a US Government Ac- from the destruction of the war, that human at the end of 2008, a shot of adrenaline for countability Office survey, textbook prices capital is the most productive of invest- the sector. Yesterday, he cited it as the most almost tripled between 1986 and 2004. ments. Today, however, the name of Schultz important thing the government has done More than half of the students involved in is practically unknown, as is the reason for to help the industry cope with the soaring one national US study say they have decided his celebrity status in the 1980s. For ours is looney.” to go text-free and damn the consequences. an age when the gap between the living stan- However, new technology does not take Often, there are none, as the “Required” dards of ordinary workers and artisans and care of it itself. It needs more highly trained book ends up not required at all. the industrial and particularly the financial executives and workers on the floor, more No wonder that a California public in- upper elite is ever widening. And as a result conversant with electronics and internet terest group published a report called “Ri- the name of Schultz has been virtually for- communication to direct it, look after it poff 101 – How the Current Practices of gotten except by COMER. when it breaks down as all new as well as the Textbook Industry Drive Up the Cost of That explains why the two sides of the old technologies have a way of doing. That College Textbooks.” one sheet of The Globe and Mail are not means that our Finance Minister should be on speaking terms. Or was it a tactful way looking to the education and the training of of a doughty lay-out man of expressing a the more technologically literate personnel Renew today! dissenting reflection about the direction in in our universities, secondary schools and (see page 2) which the world is headed? colleges. Is that taking place? W.K. www.comer.org October 2007 Economic Reform | 19 Rogue Financing Knows No Fatherland Rogue financing, cornered on one conti- in to bail it out after an affiliate faced dif- the governments do not bail out banks they nent, seems to have grown wings to turn up ficulties selling commercial paper to finance often – as per the Risk-Based Bank Capital on another. Thus the American subprime its operations. Requirements issued by the Bank for Inter- mortgages tailored to the need of Ameri- “It isn’t clear how much there is to be national Settlements (BIS) in 1988 allow can bad credit risks, have reappeared of all concerned over. Those with conduits say them to load up with the debt, particularly places in Germany – very different as their their portfolios are solid and not overly ex- with government bonds of developed coun- banking systems might be. The Wall Street posed to shaky mortgages. The president of tries without down payment. That not only Journal (20/08, “Debt Puts German Banks the country’s central bank, the Bundesbank, replaced the capital our banks have already in a Bind” by Carrick Mollenkamp, Edward said: ‘The heightened risks in the affected lost. but replaces it with “risk-free” loans. Taylor and Ian MacDonald) informs us: areas are insulated, and the profit losses for The loans, however, turned out to be less “People around the world are snubbing the credit institutes are limited overall.’ than risk-free. For when the BIS pushed up many types of short-term debt as credit wor- “Across Europe, a number of large banks interest rates to wipe out “inflation” shortly ries spread. That is posing particular prob- operate some of the world’s largest conduits, afterwards without even having properly lems for German banks, which issue a lot of including Dutch bank ABM Amro Holding defined what “inflation” might be, the such debt, known as ‘commercial paper.’ NV and Dutch-Belgian Bank Fortis NV, the bonds the banks had loaded up with took “Many used borrowed money to buy se- UK’s Barclay’s PLC and Royal Bank of Scot- a nose-dive because subsequent bond issues curities, some of which were backed by US land Group PLC, and Germany’s Deutsche carried a higher coupon that sold at par. mortgages contracted to people with weak Bank AG. Big US operators include Citi- And so it jogs on. One booboo leading to or no credit. Adding to investor concern is a group Inc., Bank of America Corp. and the next greater one, and the banks ever be- lack of transparency. Many banks hold their Wachovia Corp., according to a Morgan ing bailed out, because after all their basic loans in off-balance sheet affiliates called Stanley report issue Thursday.” revenue – interest rates – has been declared ‘conduits’ in German industry parlance. the regulator of the welfare of society as a “Mainly because of conduits, issuance A New Heritage of Euphemism whole. of asset-backed commercial paper has ex- “The difference is that in Germany many What is absent in all the opinions cited, ploded. As of March 31, there was $983 bil- smaller banks have relatively large conduits, is a mention of the one important factor that lion of such paper globally, up about fivefold raising concern should they have to cover led directly to this mess that is engulfing the from a decade earlier, according to Standard shortfalls. Smaller banks exposed to the world: the repeal of the basic principle of and Poor Corp. Conduits issue commercial subprime problems ‘may find that their the banking legislation brought in under paper for terms of less than a year, and use liquidity, risk-management capabilities or Roosevelt in the US that eventually became that to buy longer-term bonds paying high- financial resources are less adequate to ab- the rule throughout the Western world: the er interest rates. The bank behind conduit sorb any valuation adjustments.’ banks were not allowed to acquire interests typically collects asset-management fees and “Perhaps our sole consolation is that in any of the other financial pillars – stock investment profits. we have come into a new heritage of eu- market brokerages or other activities, insur- “As in the US, a generous assumption is phemisms – ‘conduits,’ ‘risk-management ance and real estate. Why? Because each of made that they know what they are doing. capabilities,’ ‘risk management’ or ‘the fi- these pillars had its own liquidity pool that “The conduit business model breaks nancial resources less adequate to absorb any it needed for its own business. Allow the down if the investors get nervous about valuation or liquidity requirements,’ said banks to get their mitts on these, and they the value of the securities the conduit Antonio Carballo, London team managing will inevitably be used as the legal tender has bought and stop lending the conduit director in Moody’s Investor Services Inc.’s base for near-money creation. Near-money money. In recent weeks the conduits have EMEA Financial Institutions Group.” is interest-bearing money created by being struggled to find buyers for their payer, and, Some of these euphemisms have been lent out rather than by being spent out as hap- when they have sold it, buyers have wanted with us for some time now; others we owe pens when the government produces legal sharply higher interest rates.” to the new wave of trouble. There are Saxon tender. And that – note well – contributes Sound familiar? It should. The world monosyllables that get closer to the essence as well to real inflation since it creates a has become round in a way that Kepler and of their meaning than the fancier Greek and many-storeyed interest burden in the price Newton did not even suspect. Latin-based polysyllables, but that is hardly structure. So that was addressed by raising “That is how a mid-tier German bank the purpose of the exercise. interest rates still further. IKB Deutsche Industriebank G ended up “Some German banks pushed aggres- Sometimes I cannot escape the feeling with big bills due to its commercial-paper sively into conduits to diversify their busi- that if you took, say, a bright econom- buyers that it couldn’t pay – and in need of a ness beyond German loans after 2002 when ics course graduate, who had not been recent bailout by Germany’s market regula- the European Union banned state-backed crammed with the nonsense that passes for tor and other German banks. Sachsen LB, a guarantees on some liabilities, which had economic theory in our universities today, small, German state-owned bank, became helped them achieve excellent credit rating and appoint him head of our central bank, the second German bank to require a finan- for decades.” he would do a far less disastrous job than cial rescue in less than a month, saying on That of course is a favourite phenom- the present crew. Friday a consortium of banks had stepped enon on either side of the waters. When William Krehm

20 | Economic Reform October 2007 www.comer.org