ARE WE LICKING INFLATION?
A few weeks ago Ottawa quietly applied the last of four powerful brakes to inflation — and you haven’t felt the full jolt yet. Here is the story of the desperate experiment our Government has undertaken to try to stop the runaway price of everything we buy
THE Government of Canada secretly believes that it is getting on top of inflation at last. The news is so big, so complex, so full of political danger and altogether so doubtful in its outcome that the Government hesitates to announce it. But within six months or so—if we escape international accidents—the Government should know whether its desperate experiment in deflation will succeed or fail.
Now that this mysterious story can be pieced together, its beginning emerges as early as last autumn. In October 1950, when the public’s eye was turned with glazed horror toward inflation, the Government quietly pulled the first of four gigantic deflationary levers which turned the shuddering economic machine into reverse. Such a shift takes time. Only in the last few weeks have the resulting shocks at once arrested the rise in prices and convulsed half the corporations, corner stores, junior governments and household budgets in the nation. And there will be more shocks.
The screams of protest now rending our clear northern air are as painful as they are inevitable; they provide the first real measure of this easygoing Government’s courage, but in the disease of inflation they are the first signs of the patient’s recovery. They mean to the Government that its cure already is showing signs of working. Whether the cure will finally prevail no one can be sure except perhaps Josef Stalin, who infected America with the current dose of inflation about a year ago and could repeat it.
Newlyweds Feel the Pinch
At the moment, having lived in a genial inflationary process of varying intensity since the first days of Roosevelt’s New Deal, few Canadians have begun to grasp the opposite process now in flow. All they know yet is that something queer has happened to the economic climate.
A farmer north of Toronto who thought he had arranged a bank loan to build kilns and greenhouses for a tobacco industry has found he cannot get a cent; a company that sells advertising signs throughout northern Ontario needed a temporary credit to finance its expansion and, turned down at the bank, has to collect quick money from customers who had expected more time; a man borrowing heavily to start a tourist camp on the Pacific Coast was faced with disaster until he cut down his building plans.
Thousands of newlyweds have to pay more for housing loans, if they can be obtained at all; a statesman in Ottawa finds contractors unexpectedly bidding against one another for the chance to build his new house; buyers of automobiles, washing machines and refrigerators must pay off their installments rapidly and many decide not to buy, thus pinching manufacturers and retailers.
The bewildered premier of a great province, unable to borrow in Canada, hurries to Wall Street for money to start various public works and returns empty-handed; municipalities discover that they cannot start a new bridge, school or incinerator because loans are not obtainable or cost too much.
Confusing, painful and unexpected, all this is the only alternative to something far worse the further engulfment of the Canadian dollar by a tide of rising prices.
To understand what has happened we must go back to the end of last summer when Graham Towers, Governor of the Bank of Canada, and other Government diagnosticians decided that the disease of inflation would not be cured by sticking plaster and poultices but required major surgery. These were the factors in their diagnosis:
Unable to finance the last war from taxes or by borrowing people’s real savings, the Government had resorted to sheer monetary inflation. It had tripled the money supply while the production of goods rose less than a hundred percent. The huge and little-noted increase in money supply, saved up during the war, had rushed out to buy goods when peace arrived and produced the first round of inflation. The rise in prices, as dammed-up purchasing power overflowed the market, was
really our final payment on the cost of the war. We had financed a large part of it, as all nations do, by permanently debasing our money—a cheap price, all things considered.
After digesting this shock we seemed to be on a new price plateau, high but level. Prices stopped rising toward the end of 1949 and dropped slightly at the beginning of 1950. The only apparent danger was that insufficient purchasing power would produce by last autumn a deflation, even a sharp recession such as the United States (but not Canada) had felt in 1949.
The Korean war instantly shattered all these calculations by launching America on its wildest spree of panic buying. The second postwar inflation was under way. And whereas the first inflation had been inherent in hoarded excess wartime money supplies, the second was quite unnecessary—purely the result of human fear and folly, including the extravagant spending by all governments. The people of North America were trying to buy more than industry could produce and in this mad auction sale were bidding up prices.
At once the housewives of Canada clamored for price controls—they had worked all right during the war, hadn’t tney? Why not now? The cold eyes of the central bank and the Finance Department were not impressed by the superficial fever symptom of prices. They diagnosed the disease as financial dropsy— too much money seeking too few goods. The only cure they thought could work
was to increase the supply of goods or decrease the supply of money, or both.
Since industry could not hope to produce goods quickly enough to satisfy the demand, since there must soon be less goods for the consumer as more and more were diverted from butter to guns in the defense program, obviously the supply of money should be reduced. But the supply of money was now rising in a terrifying flood every day.
Money, except in small quantities, is not that metal and paper stuff in your pocket. It is mainly a set of figures in bank ledgers. Within legal limits related to their own cash assets, the banks create money or extinguish it hourly as they grant or cancel loans to borrowers. Usually, though not always, a new loan brings new money, called credit, into existence and the repayment of the loan expunges it.
Ever since Korea the banks had been creating far too much money through their loans. Throughout the last half of 1950, Towers, a cool man not easily shocked, watched with dread the nation’s bank loans, and hence its money supply, expand beyond his worst fears. Everybody was borrowing money to buy something or to build something, which used up materials and manpower, thus reducing the supply of goods left to the consumer, who had more money in his pocket than ever.
Canada was enjoying the largest capital boom it had ever known and, on a per capita basis, probably the largest
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in human history. Its price was inflation simply because we were trying to live beyond our means—and this long before the defense program, with its further drain on our resources, had even begun.
Exactly when or how Towers and the Finance Department experts persuaded the Cabinet that the time for drastic action had come we may never know. Perhaps the Cabinet doesn’t remember either. These things are done with little disturbance, by a kind of official osmosis, in the neighborly atmosphere of Ottawa.
Anyway, on October 17, 1950 - a date to be remembered—the Bank of Canada moved in, an axe clutched behind its back. The official bank rate - the interest the central bank charges to private banks when they borrow money from it—was raised from one and a half percent to two percent.
In the classic and automatic economy of the nineteenth century this would have launched an instant deflation. Since the private banks would have to pay more for the money they borrowed from the central bank, they would have charged more to companies and individuals who borrowed from them. The borrowers would have borrowed less and hence the banks would have created less money. At the same time, attracted by higher interest yields, everybody would have tried to save more and spend less. The whole money supply and the public’s demand for goods would have been sharply reduced.
But the private banks had plenty of assets of their own and were not currently borrowing from the central bank. They felt no shock from the rise in the central bank rate and went on blithely pumping up the money supply as before.
Doubtless Towers had expected nothing else, but he had flown a storm signal, warning the private banks and all businessmen that inflation was getting out of hand, that sail should be shortened, hatches battened down. No one heeded the signal. Under full sail our economy was driving toward the rocks.
At the beginning of 1951, with bank loans at the incredible figure of $3.3 billions—-up nearly $500 millions in a year and still rising - Towers and the Government knew that something much more effective than storm signals was required. It was time to use the axe. The ultimate fiscal power of the state must be invoked as it had never been invoked in Canada before, except in time of total war.
The advance into this great financial experiment was casual and disarming. Early in February Towers invited the private banks into conference in the marble mausoleum of the Bank of Canada on Ottawa’s Wellington Street. The commercial bankers were not ordered to do anything, as is generally supposed. The central bank had no wish or legal power to issue orders. It merely expressed the opinion that bank loans were dangerously high.
To a commercial banker an “opinion” from a central bank is a shaking t hing. Surprisingly enough, the private banks were relieved to hear it. They didn’t like the look t>f the inflationary balloon any better than Towers and the Government, but they could hardly refuse a loan to a customer who could easily get it from a competing bank across the street and transfer his business there. If all the banks agreed to cut down loans simultaneously none would suffer a permanent loss of customers.
The private banks, therefore, instantly accepted the central bank’s advice. Thus almost without public announcement the axe of bank-loan restriction— item one in a four-point policy—began to descend on borrowers.
The plight of the borrowers (who are also voters) would in normal times be the last thing any government would care to face. In these abnormal times when short-run political gains are less important than the long-term catastrophe of inflation, a curb on bank loans, at the immediate inconvenience of borrowers, was precisely what the
Government wanted. It meant a reduction in the demand for all kinds of goods.
One brake had been applied to inflation. Three more were needed to slow down the remaining wheels, since inflation does not arise solely out of bank credit by any means. Late last spring the complete set of four-wheel brakes had been applied so smoothly that the full jolt has not been felt even yet.
The most obvious and best-understood brake was the increased taxation of the last Abbott budget. If anyone
doubts that, as item two of the program, it will reduce public purchasing power he lias not yet paid his new income tax, the increased sales tax or the brutal excise tax on luxuries.
Thirdly came a glittering, brand-new gimmick called the postponement of depreciation allowances on new business. Who of Mr. Abbott’s brain trust dreamed this one up is not clear, but the anonymous inventor was evidently a genius.
When a company builds a new plant it is allowed to write off part of the cost, in annual installments, as a non-
taxable operating cost. By withdrawing this privilege the Government could discourage many enterprisers from undertaking new construction; without the depreciation allowance it would be unprofitable. Every non-essential enterprise thus postponed could reduce the drain on manpower, materials and machinery.
In his last, budget Abbott postponed for four years the depreciation allowances on all new business ventures except those, like defense industries, judged essential by the Government. In this case the Government means
C. D. Howe, the defense-production boss.
By this means the Government can encourage the kind of industrial expansion it feels the nation needs and can afford while discouraging all others. The power the Government thus assumed is sweeping, unlimited, could be dangerous through the operation of political pressures and assuredly would not be tolerated in normal times. With his other power the allocation of many building materials Howe now bestrides the expansion of all Canadian construction like a reluctant colossus.
Even this combination of reduced bank loans, high taxes and postponed depreciation was not enough. If business and junior governments could not get money from the banks, if they were ready to pay the Government’s taxes, if they disregarded depreciation, they could still borrow money and spend it by selling bonds, and they could borrow at low interest rates.
All interest rates are geared to the current yield on Federal Government bonds. As the price of Government bonds falls on the market, interest rates all rise, and vice versa. A central
bank, by purchasing bonds if they threaten to fall or selling accumulated bonds if prices rise, can govern their price and the general interest rate.
A rise in interest rates was clearly needed to reduce the expansion plans of junior governments and business. But Canada could not risk it alone. If interest rates rose here far above those of the United States eager American investors would pour money into Canada to reap the larger returns. This would add dangerously to our excessive money supply.
Fortunately, at the very moment when Canada most required a higher interest rate the United States Federal Reserve Board won a year-long fight with the United States Treasury, pulled the props from under U. S. Government bonds and, by refusing to buy them in as formerly, let the price fall. Anticipating this, Canadian investors already had begun to bid lower on Canadian bonds. The bond market in both countries softened, interest rates roseall according to plan. In Canada the fourth brake had been clamped down.
The Arctic silence of this land, already pierced by cries of anguish from business, junior governments, individual borrowers and installment buyers, was now further rent by the complaints of little bondholders who saw their hundred-dollar Victory bonds drop to around ninety-seven dollars (though they would be worth the full hundred dollars of course at maturity). Some critics shouted that the little man, the patriotic saver of wartime, had been betrayed. The fact was that the Government was using the interest rate mechanism, among other things, to protect the real value of the investor’s bonds, to try to guard his dollars against a further loss of their value through further price increases.
It isn’t true, as some Canadians believe, that the Government ever guaranteed to hold its bonds constantly at par. The record shows that under continual pressure from the CCF James Ilsley as minister of finance and Douglas Abbott as his assistant repeatedly refused to give any such undertaking. They could not give it without throwing away in advance the final weapon against inflation.
By the end of June, with the fourwheel brakes in full operation, a lot of people were getting hurt temporarily. The Government believed, however, while keeping its fingers crossed, that perhaps the great watershed of high prices in Canada had been quietly crossed in the night provided that other nations, especially the United States, would continue in the same direction. And that is a big IF.
“With luck,” an official authority pre-eminently qualified to give an opinion, told me, “we should have inflation licked by autumn. But we still need luck.”
This must sound like sheer lunacy to the housewife. She sees only retail prices in the stores. She doesn’t know that the worst pressures of inflation actually eased off at the first of the year when, after the panic buying of 1950, business found its inventories too high, the consumer had generally got that new' refrigerator and the U. S. wholesale price indexthe world’s central thermometerhad flattened out.
It takes time for wholesale prices to reflect themselves in retail prices. In March the Canadian cost - of - living index rose 2.1 points, less than half of the 4.5 rise in February. In April the rise of .2 points was insignificant to the housewife but highly significant to the Government. The brakes apparently were working. The Government will be surprised and disappointed if prices show any serious increase
during the rest of the summer. It has, or thinks it has, a breathing spell in the inflationary spiral. If our fiscal measures succeed as planned there is a chance that the breathing spell will be extended into a permanent cure.
The Government is not ready to cheer yet. Having burned his fingers before, Abbott is making no promises to Parliament. There are too many big IPs in the economists’ pat equation.
If, for instance, there is another international incident, setting off another buying panic even far short of world war, it could smash all the monetary safeguards now erected.
If the United States fails to maintain the Federal Reserve Board’s deflationary policy or to levy enough taxes prices will certainly rise after the lull and soon spill over the border.
If Canadian labor unions win too large an increase in wages it will be translated into prices a little later on, no matter how well the fiscal methods work.
Or if total Canadian production falls we shall have reduced the money supply only to find that the supply of goods has been reduced also, and the old inflationary unbalance will remain.
Pressure from the Provinces
A reduction in working hours and hence of industrial output is officially regarded as by far the largest economic danger in front of Canada today. Hence a Government which facilitated a forty-hour week on the railways after last year’s strike is now desperately pleading with labor to work “harder and longer.” Hence Abbott’s appeal for forty minutes’ extra work a day to maintain our present supply of consumer goods, provide a ten percent increase in output for armaments and help to beat inflation. Hence also the most disturbing economic news of recent times is that this nation, for all its new machinery and skills, has not increased its productivity per capita in the last five years, mostly because it has chosen shorter work hours and an easier life in preference to more goods.
All these things considered, we shall need more than luck and monetary policy to beat inflation. We shall need in Ottawa a degree of political courage higher than we have seen in current memory and we shall need in Canadian households a degree of intelligence and patience never seen except in time of war.
The Government must stand up to the pressure of provinces and municipalities, which will have to scale down their building plans; of business concerns that want to expand and cannot get the money; of wage earners who think they can beat inflation by raising money wages—sure to cancel themselves out in higher prices; of housewives who think inflation can be beaten by an easy control of prices, an attack on symptoms; of pressure groups that demand higher governmental spending (which is just another demand for goods) and in the same breath complain against higher taxes; perhaps of men temporarily unemployed as some industries run short of materials or slow down during conversion from civilian to defense production. And the Federal Government will have to watch its own spending.
It will take some time for business and consumers to understand the deflationary forces at work but before this is printed the Government probably will be under the first real fire of its long charmed life. Then the hard inner mettle of Louis St. Laurent will be tested.
If he retreats, if the deflationary
program is relaxed prematurely in response to public clamor, if the Government is driven into direct price controls which it knows to be unworkable, then the chance of victory over inflation will be lost. The breathing spell will quickly end. The value of every Canadian dollar will plummet still further, the housewife will be harder pressed by prices and private savers will be crucified all over again.
At first glance the deflationary policy looks grim and daunting. In fact, Canada is not asked to accept any inconvenience worth the name of sacrifice. The bark of deflation is far worse than its bite. The real question is whether the bark actually contains enough bite to do the job.
This whole process, stripped of economists’ jargon, can be put in a layman’s nutshell: About ten percent of our total output must go into armaments and be lost to the consumer. Unless, as a producer, he raises that output by ten percent he must live on 90 percent of his present supply of goods. That will still leave him with at least the second highest living standard human beings have ever known anywhere. We have only to cut down our industrial expansion and our governmental and private spending a little to bring our affairs into balance. Compared with the alternative, this is not much to ask.
If we lack the sense and stamina to accept the cleansing medicine of deflation in a minor dose we shall have to take it later on anyway, massively and with far worse pain. We have been living beyond our means and must ultimately live within them. At some point deflation must occur, either by sane and orderly methods like those now in train or by such an increase in prices that people simply cannot buy and the whole economic structure will topple of its own accord in another depression.
Having reversed its direction, the Government could go too far, slowing down essential industrial expansion, reducing output by throwing people out of work, preventing vital provincial and municipal works. No one in Ottawa foresees any such danger. The only question is whether the deflationary measures up to now will go far enough, both here and in the United States. The last public figures, showing bank loans still on the increase as late as March 31, are not reassuring to the deflationists and must change radically before autumn or the Government will know that, in spite of the temporarily arrested cost-of-living index, its policy is failing.
To say that we have inflation licked, as some of the optimists of Ottawa say, as the Government and men like Towers are too wise to say, is certainly premature. But by the year’s end we should know one way or the other —barring of course another inflationary infection from the Politburo.
The answer will depend less on the Government and the central bank than on the Canadian people. They say they don’t want inflation. They were horrified when this writer six months ago asked the perfectly logical question of that time-whether our cUllar would some day be worth twenty cents. Have they now the courage and wisdom to accept the corrective of deflation which can prevent that result?
Tapering off from America’s long inflationary spree will be disagreeable, like any hang-over, and we cannot be sure of our sobriety yet since it’s at the mercy of international forces beyond our control. But if monetary deflation doesn’t work nothing else will, except the certain alternative of a grand smash a little farther along the broad and easy road to ruin. ^