THE PROBLEM

However, the economic expansionist policies of the 1950's along with a touch of inflation soon got the debt under control, to the point that by the early 70's it was barely a factor in government planning.

Unfortunately, the huge debt we now face is now causing us to impoverish ourselves to maintain the interest payments. The sooner this debt is eliminated, the better. While the Liberal government of Jean Cretien has been making good headway against the annual deficit, interest payments on the debt absorb huge amounts of taxpayer's dollars while generating none of the social goods or services we want our governments to provide.

Do not think the problem is over. The federal government, in eliminating the deficit are merely keeping the debt from getting larger. It does not reduce it. To pay off any part of the debt would require that the government maintain a surplus for the indifinite future, possibly for as long as 50 years. The writer does not believe that any government can keep this up once the emergency of not letting the debt grow larger has passed.

However, the ways proposed to eliminate the debt usually are either to reduce spending drastically or increase taxes. However, any cuts in spending mean reduction in spending programs that stimulate the economy while substantially higher taxes may cause the economy to falter as well as cause a backlash from tax payers.

After all, look at the outcry we had over the GST. All that fury though it was merely replacing a hidden sales tax and besides most European countries already have one, often as high as 15% and up to 25% in places. They usually call it value added tax. Combined with provincial sales tax, total tax added at retail varies from 7% to 18% across Canada.
 

Why did the government resort to borrowing to finance its expenditures?

All three levels of government in Canada borrow to supplement tax and non tax revenues. Before the 1960s, borrowing was generally reserved for large economy enhancing capital expenditures, emergencies or abnormal situations. Much of the debt of the federal government, as of 1946, was the result of borrowing to finance World War II. With the emergence of Keynesian economics and the acceptance of deficit financing to stimulate the economy, governments have tended to rely more heavily on borrowing to raise funds. However, most economists feel Keynes meant borrowing was to be reserved for covering government deficits in periods of unemployment and economic decline.

Borrowing has also been used to finance general government expenditures when revenue has fallen short and governments were reluctant to raise taxes or create money, like during an election year. At the municipal level, borrowing is usually used to finance capital expenditures which, if financed by taxation, would result in a large tax burden during the period the expenditures are made. Borrowing permits the government to spread the burden over a number of years and this is perfectly alright for substantial capital projects which yield benefits to the community over a number of years in the future. Examples of such projects are highways, schools, hospitals, sewage plants or electric plants.⁽¹⁾

Borrowing to pay for day to day expenses is begging for trouble. After all, the bank will loan most of us money to buy a durable item like a house or car. However, ask them for a loan to buy groceries and imagine what the answer will be.⁽²⁾

The debt problem has been caused by borrowing money for general revenue and not for specific economy enhancing capital goods or infrastructure.

INSTRUMENTS OF DEBT

Securities may be marketable or nonmarketable. Marketable securities are bought and sold in the bond market in the same manner as shares in the stock market and their prices fluctuate. Nonmarketable securities do not trade and are nontransferable.

Securities may also be callable or noncallable. A callable bond is one which may be redeemed, or called in, by the government prior to its maturity date. This feature, however, is not commonly used as it diminishes the attractiveness of a security.

The federal government issues several different securities including treasury bills, marketable bonds, Canada Savings Bonds, and special nonmarketable bonds, as well as notes and loans payable in foreign currencies.

Treasury bills (T-Bills) are short-term securities with maturities of three, six and twelve months. Three-month and six-month bills are auctioned on a weekly basis and are sold at a discount on face value to provide an investor with a return. They are redeemed at face value when they mature. The Bank of Canada is often the government's agent in the sale of T-Bills. The bills are sold to certain recognized organizations on the basis of the lowest discount rates submitted in the bids. Therefore, the rate is often called the "discount rate", especially in the USA. Treasury bills are transferable and are often resold by these purchasers to other investors. Until the February 22, 1996 the weekly auction of treasury bills basically determined the bank rate, the rate of interest the Bank of Canada charges the chartered banks on funds they borrow from the Bank. After that date the Bank of Canada set the bank rate to the upper limit of the Bank of Canada's operating band for the overnight rate. This change allows the governors to change interest rates daily if they choose.⁽³⁾  It also means that the governors of the Bank of Canada now have direct power over interest rates and they are set at whatever rate the governors feel will accomplish whatever goals they want to accomplish. With the auction method, the market had some say in setting rates. Now, it is left to a committee in Ottawa. Which method is better? Who knows. Sometimes a few carefully selected, good people acting in the common good can do much better than the market in setting these things. However, it is also a great power that could be abused.

The bank rate is usually changed in the late 90's in response to the exchange rate of the Canadian dollar against the US dollar. A secondary thing afffecting interest rates is the inflation rate. The Bank of Canada wants to keep the inflation rate within a certain range and uses interest rates as the lever to maintain this. The bank rate is also viewed as an indicator of the trend in interest rates in the economy.

HISTORY OF THE NATIONAL DEBT

1976 - The federal deficit climbed to over $3 billion. In the middle of the highly inflationary seventies, with minimal deficits, the government appears to have been caught by surprise.

1977 - While revenue rose by little over $1 billion or about 3%, expenditures rose by 14%, doubling the deficit. This was not due to over generous spending but spending merely keeping up with inflation. This was when the sudden jump in energy prices triggered the inflation of the 70's. Revenue lagged while expenditures went on as normal. The result was a deficit doubled to over $7 billion.

1978 - By this time you would think the government would have noticed something was wrong. However, in 1978, revenue rose by only 3% again while expenditures rose by another 12%. The next year was to be an election year and it appears that the Liberal government was trying to buy our votes though it did not work. The economy was not booming but neither was it in recession so it did not really need to be stimulated by deficit spending. The writer's conclusion is that the liberal finance minister was asleep at his desk. The Liberal party was guilty of vote buying or the residents of Parliament Hill came down with an epidemic of the stupids.

1979 - Finally, Mr. Trudeau and company woke up and revenue jumped a healthy 13% while expenditure rose only $4 billion. The deficit dropped to only $9 billion (as if you can say "only" $9 billion). Note that revenue in 1979 was higher than expenditures in 1977. There seemed to be a 2 year lag in the government realizing that bills need to be paid. If they could only kite all the cheques for 2 years. (By 1990 this spread period increased to 4 years).

1980 - Income rose to almost $50 billion, an increase of almost 16% but expenditures rose to just over $60 billion, a huge increase of almost 20%, way more than the rate of inflation. The tax collectors did an admirable job but the spenders overdid theirs. The biggest increases were over $2 billion each in business subsidies and transfers to persons. The deficit rose to over $10 billion again.

1981 - The gnomes at Revenue Canada collected over $60 billion, a whopping 23% increase. Pretty good during a recession. Who says you can't increase revenue during a recession. The raise prolongs the recession, but this proves it can be done and gotten away with. All this while expenditures rose by a staggering 20.2% raising the deficit to $15 billion.

1982 - The effects of recession came home to roost, probably made worse by the big boost in taxes the previous year. Collections rose slightly over 1% while outgo climbed a hefty 18%. Most of this was paid through increased UIC benefits. The deficit almost doubled to over $27 billion.

1983 - Revenue rose 5.8%, while expenditure rose 9.1%, raising the deficit to an amount in excess of $32 billion.

1984 - Revenue rose a good 10% but expenditure rose 13% making for a record (until 1993) $38 billion deficit. You may wish to note that the deficit in 1984 was greater than the entire federal revenue of 1975.

1985 - The recessionary tide was turned, and the rate of revenue growth exceeded the rate of expenditure growth. Revenue rose another 8.4%, well above the inflation rate while expenditures were held to a rise of 1.8% resulting in the deficit dropping to $34 billion. The interest on the accumulated deficit was almost $23 billion, greater the government expenditure on goods & services. This mere 1.8% rise in expenditures shows great spending restraint. However, by this time, with 30% of income being spent on interest that this restraint just wasn't enough.

1986 - Revenue went up over 11% with expenditures rising only 4.6%. The deficit was cut to $30 Billion. The biggest saving was due to reduced interest rates. This reduction shows this may be the time that control of the economy passed from the government to the international currency speculators.

1987 - Revenue was boosted about 13.6% while spending rose only about 8%, cutting the deficit about 2% to $28 billion. Every year, like this where income outpaced spending shows that restraint programs were in place. They just weren't enough restraint. The writer finds it kind of amazing that the government can boost revenue 12% in a year with less than 5% inflation without crippling the economy. Direct taxes rose over 10% while investment income rose almost 25%. This seems to imply that taxes and government spending have little to do with stimulating the economy.

1988 - Income finally broke the $100 billion level, rising over 6.7% while expenditures rose only about 6%, holding the deficit at $28 Billion.

1989 - The federal government pulled off a similar effort. Revenue rose 1.8% faster than expenditures

1990 - By this year income growth actually lagged expenditures by about 3 per centage points, probably due to the recession of 1990.

1991 - Again, effects of the recession as income growth lagged spending growth by 2.8 per centage points. The writer it may also have been due to the cabinet level of government spending all its time on the ill fated Meech Lake agreement and the constitution. This was a fine exercise in the elite of the country splitting hairs but ignoring the rest of the country.

1992 - Income rose by 3.4% while spending rose a mere 1%. Likely the effects of the lower interest rates of that time kicking in.

1993 - Income growth drops under 1% while spending grew 3%. In an election year, no one is in charge, certainly not the Tories that year, what with change of leadership and the rest.

1994 - The virtual repeat performance of 93, the writer feels is due to the new government taking a bit of time to start taking charge. Until the new crew learn the ropes, things tend to slide a bit.

1995 - In 1995, revenue rose almost 4% though spending rose even faster. Much of this was due to higher interest payments caused by uncertainty over the future of the country due to the Quebec referendum.

1996 and on - Finance minister Michael Wilson finally started tackling the deficit in earnest. By 1999, Canada will have a balanced budget. However, contrary to the publicity, the cuts made to social programs are not the main reason he has made such good progress on the deficit. While the several billions that were cut from the Health, Welfare and Medicare transfers to provinces helped, he was mainly helped by lower interest rates caused by growth in Canadian exports and by a strong US economy.

Because the US economy recovered sooner than the Canadian economy, Canada's trade surplus increased. This put upward pressure on the Canadian dollar, resulting in the Bank of Canada putting downward pressure on Canadian interest rates. They had to do this to keep the Canadian dollar from going too high and hurting our exports.

Combine this with lack of inflationary pressure behind wages, real Canadian interest rates are 1/3 of what they were 5 years ago. This is the big reason the deficit has declined so much.

If the US goes back into recession, demand for Canadian goods will fall. To keep the Canadian dollar from collapsing interest rates will go up, making the deficit go up. This process appears to have started in Novenmber 1997 with the Canadian dollar approaching record lows. However, Michael Wilson is lucky to be finance minister in a period of strong growth in exports.

Consumer spending cannot be used to grow the economy to reduce the deficit as real average incomes are stagnant and consumer debt is already near the maximum level where consumers can be expected to ever repay.

As you can see, the biggest problem years were in the early 1980's when Canada was presented with a recession by the USA and Canadian inflation fighters. Don't get me wrong, inflation is not a good thing, and has to be kept from getting too high⁽⁵⁾. The problem is that the high interest rates that were used to essentially halt inflation also substantially increased the growth of the national debt through interest charges. This means government revenues go to those who don't really need it, those who can afford to hold instruments of debt, by taking it from everybody else.

Note the data in the graphs is from Statistics Canada and Finance Canada, mainly from the Internet through such sites as http://www.fin.gc.ca.

1. Taxation and fees. This is what they extract from us.

2. Borrowing. Money is obtained by the government by issuing treasury bills (T-bills) which are sold to the Bank of Canada and others. The Bank of Canada then issues a "cheque" to pay for these. The government "cashes" this cheque and spends the money. The Bank of Canada then sells these T-BILLS to banks and others who use them for investment purposes.

3. They create new money. Basically, this is mainly the above process except that the central bank does not resell the T-bills it holds. There is a per centage of the national debt that is held by the Bank of Canada. In essence, the amount of the debt held by the Bank of Canada is "created" money. This approach could work to eliminate the debt but it tends to debase the value of the currency. That is, it causes inflation. This approach has fallen into disfavour as once started, the temptation to create "free" money is too great for mortal man to handle, and has been the ruin of many a currency.

At the end of 1996, according to the annual report of the Bank of Canada, about 5% or $25 Billion of the national debt is in the form of bonds held by the Bank of Canada.

The T-Bill is essential to the financing of the government. To pay off the outstanding T-Bills as they mature as well as to pay the interest, the T-bills are rolled over by issuing more T-bills.

CANADA SAVINGS BONDS

This unfortunate circumstance has not yet occurred in Canada as bonds held by the public have increased every year. Sales have stayed well ahead of maturations, interest, inflation and redemptions.

However, we may not find new suckers, er investors forever and funds from general revenue will be needed to pay bond holders. However, every fall people sign up and to allow the government to build yet another layer on the pyramid.

OTHER BONDS

Remember though, funds raised from any bond used for any purpose other than building something that will produce a profit or enhance the infrastructure of the country is being issued under false pretenses. Bonds only make sense if used to build a factory or other income producing asset. Otherwise they are only a fraudulent instrument robbing Peter to pay Paul.

OTHER LIABILITIES

THE DANGER

This slower growth rate may convince foreign investors to go elsewhere, driving interest rates even higher to keep the suckers money coming. This occurred in late 1989 with Canadian rates over 4% higher than US rates, further depressing the economy, resulting in a continuing downward spiral.

Unfortunately, the converse does seem to be true but with a substantial lag. Lower rates take so long to make a difference that it is hard to correlate any cause and effect. By 1997, interest rates came down to 30 year lows but with a lack of consumer and investor confidence, it seems that even a zero interest rate is not low enough. Witness Japan where even rates of 0.5% won't kick-start the economy. This tells me that interest rates don't play as big a part in the minds of consumers as the economists seem to think and only really affect the market for government bonds.

Unemployment and the deficit seem to persist even with low rates, but at least the low rates of 1997 keeps the government's interest payments down and helps reduce the deficit so not all of the balancing needs to be done through cutbacks in spending.

However, the debt has gotten so large that it is now impossible to eliminate it by spending cuts without destroying the federal government and eliminating most of the social goods provided by most of our governments.

If I were a suspicious sort of fellow I might imagine that our government did not even seriously want to eliminate the national debt. After all, though destroying our social safety net, the government is doing a good job in meeting interest payments to those financial institutions who are buying all those billions of dollars of safe government securities, even if they have to kill medicare to do it. If I thought that the impossible had occurred and that our federal politicians were friends of the investment community that they were helping their friends make money. After all, if you were an investor, why invest in a new factory and maybe make money or maybe not.

How much better that your possible friends in the government have produced an unlimited supply of safe investments that will make me a guaranteed income. Who cares that putting money into these investments won't create any more jobs. It is a good that we live in a country where our politicians are honest with us and who don't need campaign donations from the investment community and who don't even know any powerful financial people. A country where higher interest rates don't end up enriching mainly the financial community who might be friends with those who control the rates.

If you really believed in conspiracies you might think there are those in government who want to wreck things like medicare so that the public getting tired of poor service will clamour for private, for profit hospitals run by those nice American companies that must be efficient because they are profit making. You might even want to check out Calgary where the provincial closed both of the city centre hospitals (Holy Cross and the General). Of course, a few months after the Holy Cross closed, along comes a private company who wants to set up a private hospital using the Holy Cross building, offering a pittance to take the old "useless" building off the hands of the province. Basically, I see this as a way of the corporation getting a good chunk of the capital costs of a hospital at a discount, capital costs that were paid by Albertan's including my parents out of their taxes and being given away to private interests. Only the federal government's enforcement of the Canada Health act is preventing this give away.

Remember that the US health system uses up 13% of the GDP while the Canadian uses up only 9%. This while the US only covers 80% of the population while we cover 100% in Canada. Now you tell me which system is more efficient. Conspiracies. I believe there are conspiracies in place in Alberta and Ontario to ruin the medicare systems with the purpose of making the citizenry clamour for private medicine, profit making medicine with the giving away of a lot of the capital infrastructure to corporations. After all, why build when you can take over, just like is going on when one private company takes over another.

Footnotes

1. These are projects like dams and highways that will increase economic activity, resulting in increased long term tax revenues, more than sufficient to repay the borrowing. 

2. Okay, Okay. I know you can now pay for groceries on a credit card. However, only the foolish do this for very long 

3. Source: Bank of Canada 1995 Annual Report downloaded from the Internet. 

5. On the other hand too low an inflation rate causes inflexibility in wages and stagnant incomes resulting in sluggish consumer demand.