THE GREAT TIGHT-MONEY MYSTERY What’s changed since '56?
THE GREAT TIGHT-MONEY MYSTERY What’s changed since '56?
SELDOM have reporters been baffled as they were when Prime Minister Diefenbaker. back from the west, undertook to explain to the group who met him at the airport what he meant about “tight money.”
What he had said was clear: “There is no tight-money policy. There was one three years ago, but there isn’t now." Just what did he mean? What exactly did we have three years ago that we haven’t got now? This was what the questioners couldn’t quite grasp.
Very simple, said the PM. Three years ago the publicly owned Bank of Canada had imposed restrictions on loans by private banks, “apparently with the knowledge and certainly with the connivance” of the Liberal government. This time, he said, there was no such restriction by the central bank or by the government. There was a tremendous demand for bank loans, as a result of phenomenal growth of the booming Canadian economy, but if the private bankers wouldn't lend any more money it was their decision, not his. Indeed, the prime minister wouldn't admit there was any such thing as "tight money" in 1959. He hadn’t heard anyone allege it.
But to the hazy recollection of reporters, these latter sentences had a familiar ring. The Liberals, too. used to argue that shortage of bank credit was just a by-product of prosperity. They were often accused of having a “tight-money policy," notably by a couple of MPs named Diefenbaker and Fleming, but nobody could recall a Liberal ever admitting it. Neither could anyone remember the Bank of C anada doing anything substantial in 1956 that it isn’t doing now.
Four years ago the private banks were heading into the same kind of jam as they are in today. The 1954 recession was over, the 1955 boom was on. and the grand total of bank loans was rocketing up at a tremendous rate. To get the cash they needed the private banks were selling government bonds in great quantity, and the bond market began to sag. Moreover, all the banks had promised their major customers a lot more loans, still to be taken out. To keep these promises the banks would haye to sell even more bonds, drive bond prices down further, and bring heavy losses on themselves.
There was, of course, one easy way to prevent this. The Bank of Canada could buy all the government bonds that were offered for sale, and thus keep the price up. But this would be a direct inflation of the money supply, as explosive as printing a few' million hundred-dollar bills. By autumn of 1955 the money supply in Canada had already gone up a lot since the end of the recession, twdcc as much as the increase
in production. Any more expansion would mean danger of runaway inflation.
In November 1955 the Bank of Canada had a meeting with the private banks to talk the situation over. Nobody ever said so, but it’s evident from the figures that a compromise deal was worked out; the Bank of Canada did buy some of the private banks’ government bonds, to help them keep the promises already made, but in return the private banks cut down on new commitments. They agreed to make no more “term loans,” i.e., longer than one year—for amounts over $250,000. More important, they agreed to keep a higher ratio of “liquid assets” (cash and short-term loans) to deposits. By law they are obliged to keep eight percent of their deposits in cash; by agreement, since June 1956, they have been keeping an additional seven percent available on very short notice, so that the “minimum liquid asset ratio" is now fifteen percent.
Some bankers got very sarcastic when they talked about that “voluntary" agreement — they were in such a jam that they didn’t have much choice, they said. The alternatives were to break their promises and cut off their customers’ credit, or else to sell more and more bonds at greater and greater loss. It’s very doubtful, in these circumstances, whether any banker would have gone on lending money to his
customers, agreement or no agreement.
They didn’t say so, of course. The easy way for any bank manager to refuse a loan to a valued customer, in 1956, was to say: “Bill, I’d like nothing better than to lend you the money, but those skinflints in Ottawa won’t let me —they’ve cracked down on us.”
It wasn’t quite true, but it wasn’t exactly a lie, and it taught the Bank of Canada a lesson. When another recession ended and another boom gathered way in 1959, and again the supply of bank credit began to run out, the Bank of Canada made no more suggestions to the private banks of methods to meet the new situation. If or when bank managers got to the point of refusing their customers this time, they’d have to think up their own excuses.
But meanwhile, the voluntary agreements of 1956 are still in effect. The allowable amount of term loans was increased last year to two million dollars, but in practice no such loans are being made. The “minimum liquid asset ratio" of fifteen percent is still observed. although no law or regulation enforces it.
Again the private banks have been selling government bonds to get the cash they need, and again the bond market has been sagging—this time to the point where any further selling of bonds might be difficult. Again the Bank of Canada could, if it chose, come to the rescue by offering to buy any
government bonds offered for sale—but again, this would be a direct inflation of the money supply, far beyond any increases in production. So far, the Bank of Canada has not taken this risky course. And that negative decision is the heart and core of a “tight-money policy.”
Whether it’s fair to call this the government’s policy, or only a policy of the Bank of Canada, is matter for argument. By statute, the Bank of Canada is responsible for control of the money supply. No government can dictate to the governor of the Bank of Canada how he shall carry out that task. But there are many ways in which a government can force the governor’s hand, if it wants to, and so perhaps “tight money” is ultimately a cabinet responsibility.
The question that baffled reporters at the airport was “What’s the difference between 1956 and 1959? If tight money was the government’s fault then, why not now?”
It’s true that the two situations are not quite the same. Last time, the increase in the money supply all went to private enterprise; the government then had a surplus for the period as a whole, and didn't need to print any money for its own use. This time the increase in the money supply (which happened to be almost the same percentage) all went to meet the government deficits. Both times, it was the big previous increase in the money supply and the consequent risk of inflation that made the "tight money policy” necessary. If anything, it would seem the 1959 shortage is more and not less a result of government policy than the 1956 one was.
These facts are not secret. The essentials are all set forth, in tranquilized prose, by the Bank of Canada in its annual reports since 1955. Lively footnotes can be gathered from any banker or bond dealer, some of whom are more sarcastic now than they ever were. The picture was familiar in outline, if not in detail, to all the reporters who struggled in vain to comprehend the prime minister's denials and explanations.
He could have meant, and maybe he did mean, that his government won't allow money to remain “tight”—that somehow he will jockey the Bank of Canada into buying more government bonds and increasing the supply of money thereby. Indeed, this may become inescapable. The government faces a refunding operation of $550 million in October and another of about $300 million in December, besides the annual Canada Savings Bond campaign; if nobody else takes up these bonds, the Bank of Canada must. Also, the government will need a lot of new money before the end of the fiscal year —$850 million according to the budget estimate, though they may prove a bit high if recovery proceeds faster than expected (or, likewise, if we do have another round of inflation to boost the dollar totals of government revenue).
A former minister of finance, Mr. Justice Douglas Abbott, once told a parliamentary committee: "If you have a government engaged in large-scale deficit financing, the most competent operations of the central bank would be largely frustrated.”
Somehow, though, I don't think that was what the prime minister intended to convey. What he did intend is still a mystery. ★
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