So far, to solve the national debt crises I have defined 6 ways. None
of these would solve the problem. To summarize:
1. Increase taxes to increase revenue. Increasing taxes will actually reduce income and cause a revolt.
2. Cut costs & services to the bone to reduce costs. These cannot be cut enough without destroying the economy.
3. Repudiate the debt. This would make our money worthless to the rest of the world.
4. Expand the economy to grow our way out of it. The debt has gotten too large and the economy cannot no longer grow fast enough to catch up without high inflation.
5. Create money to pay it off in one shot. Hyper-inflation
6. Change the way we finance it. Some possibilities here but it is doubtful
successive governments would have the discipline to finish the job.
Even if we applied the above and while it looks like we will balance
the budget by the year 2000, this sacrifice does nothing for the debt as
a whole. We would still face a future of huge interest payments forever.
Do you think that the government would have the stomach to continue the
cuts after the budget was balanced in order to pay off the debt? While
in April 1997, the federal government reached a milestone by issuing no
new bonds for the first time in a generation, I don't think so either.
That's why a combined approach is needed. One that pays off the debt
as well as well as results in a balanced budget while not upsetting the
financial markets too much and maintains our social programs. Sound impossible?
Not if you understand the true nature of money.
With more detail to follow, I suggest that the following program be
implemented:
This sounds like hocus pocus. Monetizing the debt is considered to be
against all principles of sound money management. It is extremely bad if
done in too big a lump. That is why a gradual approach with special safeguards
is needed to minimize the damage. In more detail the steps are:
Over 100% of the deficit is interest on the old deficits since around 1987. Without old debt, the federal government would have been in a surplus position of over $19 Billion in 1995 and closer to $40 Billion in 1998. It makes sense to separate these parts of the operation. The government should be concerned with operating cash flows. Even with the budget temporarily balanced in 1998 or 1999, we are still stuck with huge amounts of interest to pay on the debt. Besides, with the per centage of the population paying taxes dropping it is doubtful the government can hold the budget in balance for long. The debt should be declared "the combined social services debt of the Canadian People" and dealt with separately. Don't argue about who was responsible for it. It is there. We are stuck with it. The time for arguing about responsibility is over.
After separating the operating portion of government expenditure from
the portion concerned from rolling over the old debt, there would no longer
be any reason to continue cutting programs. We can let programs go their
merry way with no further cuts. The federal government would then get down
to the real business of the country, figuring out what the heck Quebec
really wants.
However, once the debt maintenance and the operating budgets are separated the government would be really tempted to start overspending again. To prevent this, it would be necessary to pass a draconian balanced operating budget act. One that would be so difficult to repeal or get around that later government's would not tamper with it. Hire a bunch of tax lawyers and accountants in jail for tax fraud to find the loop holes and plug them. Introduce a "castration" clause for violators. Okay, that last sentence was a joke, but the law has to be a serious balanced operating budget law even though it could be a law requiring balance over a five year period with surplus years required before deficit years in a business cycle.
Since the government, without having to deal with the debt from current operations, would be in a surplus position, it would be easy to pass a balanced operating budget law. After all, who could possibly be against it. The right has been demanding one for years and with no further program cuts, the left would grudgingly go along as well. The law would be simple. Pay as you go. When the money budgeted to a department runs out, that's it for the year. Shutting down a department 2 months before the end of the fiscal year would be very embarrassing. If it is a really essential service that ran out of money, such as medicare, the GST would have to be raised until the next fiscal year to cover the shortfall. Of course, the heads responsible for overruns would have to roll.
Each department would be budgeted on last year's revenue. Any growth in revenue is a bonus for next year only. The law would have to require the resignation of the Prime Minister and Cabinet if they ever again ran an operating deficit. Except for a national emergency, to prevent tampering, changing the law would require something like a 2/3 majority of both the Commons and the Senate as well as ratified by 7 provinces representing at least 66% of the Canadian population.
The people of Canada would have no problem in standing behind such a law if it were kept simple and was bulletproof. Any new programs proposed would require a specific new tax to pay for them. After all, the damage now being done in the name of deficit control is far greater than the benefits we received from the deficit spending of the late 70's and early 80's that got us into this mess.
This proposal will not work for long if a strict balanced budget
law is not included as part of the package. Without it future governments
will only run up a big deficit again and solve it again this way. This
cycle will repeat with shorter and shorter cycles, triggering massive inflation.
This plan will only work well if it is used no more than once in a century.
The balanced operating budget law has to be really tough.
This is the most critical part. It depends on the theory that if a borrower owes $1,000 and cannot pay, the borrower is in trouble. If the borrower owes big money, into the millions to billions and cannot pay, it is the lenders who are in trouble. A surprise announcement would be made announcing that all outstanding bonds and other securities, no matter what the term or when they mature, will be replaced with bonds maturing in 25 years from that date. This includes T-Bills, Canada Savings Bonds, etc. Argentina did a similar thing in the early 90's where almost all bank deposits were converted into long term government bonds without the permission of the depositors.
These bonds would be bearer bonds in that they could be freely bought and sold on the open market. The market should embrace these freely as 100 cents will eventually be paid on every dollar, with interest above the inflation rate. Therefore, anyone who needed immediate cash could sell their bonds on the open market for whatever the market feels they are worth.
Also, once these bonds are issued, the federal government would be out of the securities business. This could be put in the balanced operating law as well. All further spending would be pay as you go. It is not the function of government to provide instruments of investment. The function of government is to manage the common interest of its citizens.
All bonds denominated in foreign currencies would be converted into Canadian dollars at the rate prevailing 30 days before the announcement.
Bond holders would receive an annual principal payment of 4% of the bond's original value and an annual payment of interest on the unpaid balance still owing. The interest rate will be the official Canadian inflation rate of the second preceeding year plus 2%. That is, if the 1996 inflation rate was 3%, the bond holders would receive 5% interest for 1998. The 4% principal payment means the bonds are retired in 25 years.
Using late 1995 figures for the debt and interest rates, in the first year, this would mean paying out about $36 Billion in interest and an additional $22 Billion in principal for a total of some $57 Billion or about 10% of the GNP of that year. In later years, interest payments will fall as the balance outstanding would be declining. The small rise in inflation in early years of the program may cause interest rates to rise a little but this effect will be only for a few years.
To reduce the shock of a big payment all at once each year, the funds could be electronically deposited monthly in the bond holder's bank account.
The big catch is where the money will come from to pay the vast sums above. The first source would be the government surplus generated by separating the debt from other spending. In the 1995 budget, this would be about $19 Billion or about 30% of the total. By 1999 this could be as much as $40 billion.
Some would come from specific Debt retirement taxes. However, this would only be $1 or $2 Billion. The rest would have to be created by the Bank of Canada. For information n the Bank of Canada check their home page at www.bank-banque-canada.ca/.
Before you start screaming that this is "inflationary monetization of the debt" and reject it out of hand, bear in mind that about 5% of the debt is already held by the Bank of Canada, meaning that this 5% is merely a bookkeeping entry in a computer. This would be a case of merely cancelling out bookkeeping entries for about 5% of the payments each year. This money has already been "created", entered the economy and already done its inflationary damage.
Therefore, with government surplus covering part of the payments, debt reduction levies and cancelling debt held by the Bank of Canada, about 50% of the money "paid" out in the first year would be covered in a completely non-inflationary way.
The rest would have to be new money created by the Bank of Canada(1). Yes, this is inflationary but look at the alternative. Without this, the eventual monetary collapse would cause an uncontrolled inflation. That would wipe out everyone. This especially includes the people the left wing calls "the rich". "Investing class" may be a more accurate label.
With this approach, inflation will be controlled and the investing class will still see the fruits of their investment. The amount of money to be created would have to be about $30 billion in the first year, or about $1,000 for each person in Canada. This would result in the "GNP" being increased by about 5% that year. However, this will not cause a 5% rise in inflation.
The reason is that this "new money" would be paid to persons and institutions which already had sufficient surplus income that they were able to invest some of it. Suddenly, the investing class would see all this investment money returned to them as their new bonds were paid down every month. The bond holders would have to find new investments in which to put these funds.
Bear in mind that the interest portion paid out is taxable. However, since this is capital gains and many of the big funds are tax free as they represent RRSP investment, the government would only collect about $3 billion in taxes. This alone is good news and while this money should go to further reducing the debt, it would undoubtedly go into general operating revenue. However, it would help provide more social services which is why the government exists anyway.
Also bear in mind that when debt is paid off, the
money that was created when that money was borrowed disappears in a way
from the economy, resulting in a smaller money supply. This method replaces
the money that is circulating with new money. The money supply will only
grow by the amount that was borrowed through debt instruments based on
actual money and not on money created by a bank or other money creating
institution.
EFFECT ON FINANCIAL MARKETS
This wad of new money would create a field day for Bay Street. Suddenly there would be a bonanza in commissions to be made and the stock and private bond markets would jump dramatically. The TSE would probably jump 500 points in the week the first payments were made. After all, this investment money would have to go somewhere and rises in the stock market are not considered inflationary. Money managers for funds heavy in T-Bills would see a large chunk of money given back to them. To make a return for their investors with no more T-Bills to invest in, they would have to invest in the private sector or foreign T-Bills. The additional money available for Initial Public Offerings alone would rejuvenate a large chunk of our industry.
Even if the GNP increased a full 5% in the first year, since Canadian industry is operating at under 80% of capacity, the 5% increase in GNP should be able to be soaked up quite well. There is no reason to worry about reaching production capacity limits. The Chinese have loads of capacity and are willing to take all the money we can send them. This is a back handed way of saying that domestic production limits are meaningless in our globalized markets. Economists who worry about over reaching our capacity are still living in the 50s. However, the TSE 300 should jump by over 20% the first year. Those who are into TSE 300 stocks or mutual funds would make a killing.
The new pool of money would bid up corporate bonds quite a bit which would reduce interest rates on bonds, making it easier to finance new capital expenditures without diluting shareholder's equity in a company.
In other words, the rich would get richer but the
poor would stop getting poorer.
Remember, this would be a stable, 25 year program
with no surprises. That is why the interest rate is determined by the inflation
rate of the second previous year. The financial markets have proven themselves
very adept at handling big changes if what is going to happen is predictable.
When a slug of new money hits the market each month, the effect will be
absorbed easily as the money traders can see it coming.
If you don't understand where the money is coming
from, re-read the chapter on money. Remember, money in the quantities the
government uses, is nothing but data on in a computer. If a hacker bumped
an account with billions in it by a few million, no one would notice. The
writer is proposing that we so the same thing but with the weight of the
government behind it. To the Bank of Canada, operating on a "macroeconomic"
scale, money is not the same thing it is to us operating on a "microeconomic"
scale.
EFFECT ON INFLATION
With the stock market going up and absorbing the majority of the "new" money, this plan would not add more than 3% to inflation if even that much. After all, foreign exchange traders now move hundreds of billions of dollars around every day. Having a few tens of billions extra each year is nothing in comparison.
Since the markets could anticipate the surge in funds, it is even possible that the investment community will absorb the amount without a trace of inflation at all. According to Kenichi Ohmae in "The End of The Nation State" the Japanese market alone pumps US$400 Billion per year into the worldwide investment system with no real effect on inflation. Our initial input will be little more than 10% of theirs and would decline each year thereafter.
A 3% rise in inflation the first year and declining thereafter is about the worst that will happen. 3% on top of today's virtually nothing is still within sight of the ball park for acceptable levels for all but the most conservative of inflation fighters.
As the amount paid each year declines with the reduced interest on the steadily declining balance, the effect on inflation will become less and less every year. After a few years, the influx of money will become such a predictable thing that it will barely be noticeable.
Now, some will argue that deliberately triggering some inflation is bad. It is. The writer admits it. However, there has to be some pain involved. The debt does not get paid off for nothing. An extra three points of inflation for a number of years is the price paid to stop further cuts. No pain. No gain.
However, I remember the 70s. They were not that bad. I know we whined about the stagflation(2). However, compared to today, the economy of the 70s starts to look pretty good. Besides, if not when inflation is almost zero, when else would be better to introduce a controlled amount of inflation to stabilize our economy. Better a planned 3% rise in inflation than an uncontrolled 25% to 100% rate sometime after the debt exceeds 150% of GNP.
There is no free lunch but a bit of controlled inflation is the least burdensome weight to carry. It divides the burden amongst the entire population and more or less proportionately with ability to pay. Some say "What about the pensioners?". Yes, pensioners will be affected. The same people that will feel the worst effect will be the same people who benefited from the huge increase in home values and the same people who benefited most from the run up in the deficit for the past 20 years. Some inflation adjustment in their pensions will be necessary, but this can easily be absorbed in the surplus in the operating budget. Also, those with private savings will make a killing as mutual funds follow the big rise in the stock market.
On the other hand, it will allow for more labour market flexibility. By workers wages possibly being raised by less than the inflation rates it will be possible for companies to reduce their real wage costs and become more competitive internationally.
Meanwhile, for those in their 40s who are looking to retire in about 20 years, the worst effects will be over by then. For those under 35, the effect won't be any worse than living through the 70s. In the 80s we thought the 70s sucked but in hindsight, other than the oil "crisis", leisure suits, disco and the Ford Pinto/Chevy Vega they were not all that bad. The writer ran a small business all through that time and it was a lot easier then than it is now.
By the time the younger folks near retirement, things will be on an even keel and they will be able to look forward to a secure old age. We will have restored their inheritance.
Only those now in their 60's and 70's would suffer
a bit and some indexing along with increases in contributions will minimize
this. Perhaps there could be an inflation supplement for those who failed
to cash in on the home equity bonanza of the 1975 to 1989 period.
EFFECT ON THE CANADIAN DOLLAR
This would have some effect on the dollar. We would no longer need to have huge flows of capital coming in from foreign countries but would have an outflow to pay down the portion of the debt held by foreigners. This will cause downward pressure on the dollar. On the other hand with the TSE soaring, a lot of foreign money will come in to invest in a rising market putting upward pressure on the Canadian dollar.
Also, some of the money released by paying the bonds would be invested in foreign T-Bills, resulting in an out flow of money. While this would put more pressure on the dollar, each dollar that left the country would be a dollar less pressure on domestic inflation. The two pretty well cancel out.
However, for an enlightening read about what really moves exchange rates, go to the library or your book store and read Appendix A in Kenichi Ohmae's "The End of the Nation State". With the markets already processing $200 Billion per day our little bit will be lost in the shuffle. A seven day wonder, if that.
While for a few days, the dollar would be somewhat depressed and the short sellers might make a few bucks. However, considering the underlying strength of the economy, a slump of 5 cents should be all we get and only for a few days. To prevent a run on the dollar, the international currency market would have to be reminded by the Minister of Finance and the Governor of the Bank of Canada that all of the new bonds were re-denominated in Canadian dollars. If the money traders want to bid down the Canadian dollar, they are cutting their own collective throats as they are only devaluing the bonds held in Canadian dollars while at the same time making Canadian industry more competitive while cutting Canadian demand for foreign goods. It would be suggested to the speculative traders that they lay off the Canadian dollar for a few weeks and only trade in real demand for buying and selling the Canadian dollar. Some scum; er, I mean short sellers will try to take advantage but I think most of them will get badly bitten if they take short positions more than a few days.
Also, considering time frame used by international money traders (6 hours ago is ancient history), by implementing the plan during the middle of a US election campaign, either presidential or mid-term, possibly a few days right before the voting would make the news get lost in the background noise. A presidential election is best but in the USA, even an election for dog catcher would distract attention away from something happening in Canada.
The dollar will dip a bit but with the big rise in Canadian stocks and private bonds, the amount of money that would really leave the country would be minimal. The Canadian market would be hot and would attract as much money into the country as would be lost from paying out foreign investors.
If anything, with no more demand by the federal government for investment money, coupled with a buoyant market in private securities that overall effect on the dollar, after a few weeks, would be positive, or at the very worst, neutral.
EFFECT ON SMALL INVESTORS
Since the new bonds would be registered(3) bearer bonds, bond holders would be free to trade these on the open market. This way, the financial industry can still make the commissions it formerly made dealing in T-Bills.
Anyone who needs their money right away would be free to sell them at whatever price the market sets. Since the bonds would be guaranteed inflation plus 2% interest and would pay back principal in full, the bonds would probably trade at face value less the part of the principal already paid out to the holder. The mechanism of the market in trading these bonds privately is best left to the market. Because of guaranteed return above inflation, they may even trade at a premium. The investor is protected against inflation, especially if they feel that the new stability of the Canadian dollar will make the Canadian dollar appreciate. A foreign investor, if they feel the Canadian dollar will go up, can realize a real return of 10% to 15% if they are careful.
This market would also create new opportunities
for investors to make money, replacing the speculation on T-bills that
goes on now. The derivative boys could go just as wild in this market as
they do now in T-Bills.
EFFECT ON INTEREST RATES
With this plan, the government would be out of the securities business. The setting of interest rates would be primarily be up to the market. The federal government would still be able to influence rates somewhat by adjusting Bank of Canada rates for overnight lending to banks and by manipulation of the reserve ratio required by banks. However, the government role would be limited to a watchdog who would act only if the market got a bit too wild.
The return to a purer market along with a large pool of money looking for investments would result in such competition for borrowers, lending rates would most likely decline even further from today's levels probably towards Japanese like levels.
However, rates will spike up for a short period, possibly for a couple of months after introduction of the plan until investors got used to the idea of a controlled amount of money creation and inflation. I suggest that Canadians stop borrowing for a month or so after the introduction of the plan. The surge of money with no place to go will cause the market to correct very quickly and the magic of the market will make rates go back down just as quickly.
The drop in rates would be especially good for home owners. The market purists will be able to find out if they were spouting BS all these years or not.
The writer believes that the act of the government
taking a long term plan and putting it into place removes a lot of uncertainty
about the future. This would increase investor confidence to the point
that we would be considered on par with the Swiss for being a good place
to put your money. Even if the returns were lower, a country which stabilized
its currency through long term planning, would be an extremely good place
to invest. Especially, without the government sucking in huge amounts of
money, quality investments would be harder to find, driving the cost of
money down for Canadian companies and for the people.
This concept follows the principle of the way World War II was financed. Does anyone honestly think that Hitler, Churchill, Stalin, Tojo, Mackenzie King or Roosevelt checked their country's bank balance before deciding to fight the war? To fight total war meant that money was irrelevant. The Germans sure did not worry about the cost of bullets. Neither did we.
How do you think Hitler took a country that went bankrupt in the early 30's and suddenly starting building all the armies, air forces and navies necessary to start the war? Yes, some of it was wealth stolen from the Jews. The writer means no disrespect for the victims of the holocaust, but that stolen money was merely a drop in the bucket. The confiscated wealth of the millions of Jews may have been enough for a few dozen squadrons of bombers and a few army divisions. The war machine was built because the leaders, evil they may have been, wanted it to happen.
How do you think that a country like Canada where there was malnutrition in the 1930's, where Newfoundland sent food aid to Saskatchewan(4), where 25% of the country was out of work, where 10 years of market activity could not restore the economy managed to pay to put a million men and women into uniform a few years later. They had to have made up the money.
Remember those war bond drives that are featured in movies made during World War II. Sure, the money raised was used to buy weapons, but if not enough bonds were sold do you think the arms factories were going to shut down. Not a chance. The government simply wrote cheques to buy what they needed and if some was covered by bond sales, great.
The real function of the bonds was to reduce public buying power to reduce the amount of inflation. All those war workers were making good money but there was little to buy. Too much money chasing too few goods causes inflation. To reduce the likelihood of inflation, war bonds were used to soak up those excess dollars. The dollars were then released back into the economy after the war. The government had a big fear of a return to the depression after the war. The money released by people cashing in war bonds prevented it. Where did that money come from to pay the bond holders? The government sold more bonds, more and more every year. They are part of our current national debt.
A secondary purpose of the war bonds was to build
public morale to make everyone feel they were doing their part. Remember
that there is no way arms production would have dropped by one bullet if
not enough bonds were sold. The "establishment" felt we had to fight the
war and the supply of money had nothing to do with it. We were at "total
war".(5)
WHO BENEFITS
Lets see now. No more cuts means stable services and stable incomes for government employees. Government employees with steady income start to spend again resulting in more jobs in the private sector and lower unemployment. This results in more tax collections which helps the government expand services.
Medicare would no longer be threatened which would assure re-election of the party who implemented this plan.
Increased consumer spending results in more corporate profits. After all, most companies have already downsized are as efficient as blazes. They are not even "lean and mean" They are "skinny and pissed". There is no more profit to be squeezed from further down sizing.
All that extra revenue from this plan is marginal income, which is far more profitable.(6) The investing classes make a lot more than now. The boom in profits will last several more years instead of tapering off like it now must.
Basically, both working people and the investing
class do better. In addition, the non-working class shrinks, converting
many of them into working people. Those unable to join the working class
will do better as well as there would be no further erosion of government
support.
WHO SUFFERS
We all do a little. After all, in the early years of the plan we will have to suffer through a little bit more inflation and possibly slightly more expensive imports and foreign vacations. Retired people on a fixed income will have it worst. However, they seemed to manage through the much higher inflation of the 70's and a smaller inflation rate now will not damage their incomes any worse. The increase in inflation will subside in a couple of years anyway. For those truly in need, government benefits could be boosted a bit, paid from the operating surplus we would have.
Also, with lower unemployment costs, some of the
money saved there could be diverted to pension supplements.
CONCLUSION
To restate the plan in summary:
1. Separate the operating budget from the servicing of the debt.
2. Pass a tight balanced operating budget law.
3. Convert all existing government securities into bearer bonds denominated in Canadian dollars. These would be payable over 25 years with interest rates based on the inflation rates of at least 1 year ago.
4. Partly pay these bonds with money from the operating surplus. Create the money, through the Bank of Canada to make the balance of each year's payments.
5. Initiate some anti-inflation measures.
By doing this, we can stop cutting services and get back to creating a better country. We can stop the pain that threatens to no longer make this the best place in the world to live.
1. This will probably require a new governor at the Bank of Canada. The writer feels that the present governor would only let a plan like this occur only "over his dead body". So be it (metaphorically speaking).
2. Stagflation means there was high inflation (by our standards) as well as a stagnant economy.
3. By this I mean that the owner would be electronically registered so that their payments could be credited to their bank accounts. This could be transferred to any other person or organization through any proper financial institution or trading organization.
4. Honest! My mother ate some of the dried cod sent to Saskatchewan on a relief train.
5. The only time it was a worry was before the USA entered the war and Britain had to pay gold backed cash for weapons imported from the USA. However, the Sterling crisis of 1940 did not cause the domestic production of Spitfires and Hurricanes to falter one bit.
6. Marginal income is where your existing overhead is covered by your existing sales. The new sales are at the "margin" of your existing volume. All the new sales cost is your cost of direct inputs, that is direct labour and materials only. Hence, since these new sales do not need to pay a portion of the overhead, they are far more profitable.