OTTAWA’S BIG PROBLEM: How to solve our money troubles?
BACKSTAGE AT OTTAWA
OTTAWA’S BIG PROBLEM: How to solve our money troubles?
PARLIAMENT IS DUE for a shock as it reassembles January 15. The government is in financial trouble that may become as grave as the dollar crisis of 1947 which led to import controls and exchange restrictions. There is no clear indication yet of plans for meeting the problem, but the alternatives are all unpalatable:
1. A sharp cut in spending — very hard to do with unemployment still headed for a postwar high. The government's spending estimates for 195960 have already been compiled, and are said to be higher, not lower, than those for the current year.
2. A sharp boost in taxes—equally painful. The government cut taxes by $200 million last year; to reverse that policy now. when recovery from the recession has not yet shown itself in the employment figures, would be very difficult indeed.
3. A sharp drop in the price of government bonds, and therefore a sharp rise in interest rates on all borrowing —“tight money" again.
4. A sharp jolt of inflation (i.e. a severe rise in the cost of living) if the government obliges the Bank of Canada to keep bond prices up. and interest rates down, by buying the bonds that the public won’t take.
This is not an exercise in prophecy. Alternative No. 3 has already arrived. The price of government bonds has been sagging since early November. That's what brought on the threat of financial crisis.
At present the government has to borrow rather more than $100 million a month to meet its cash deficit. Finance Minister Donald Fleming budgeted for a deficit of $700 million (some people think it will run as high as $800 million in fact) but that is only about half of what the government has to borrow. Cash is also needed for non-budget ary outlays’ such as housing loans ($400 million) and similar items. The total cash deficit for the current fiscal year will be around a billion and a half, all of which has to be borrowed.
Already, private borrowers are showing themselves less than enthusiastic about lending money to the government. Their reluctance can be seen in the bond market.
l ast summer the government issued long-term conversion bonds in exchange for the victory loans still outstanding, and offered 4Vi percent interest. Not for a generation had a Canadian government bond paid such a high rate. Yet by mid-December, the price of these seemingly attractive securities had slid to $94.50 for a hundred-dollar bond.
This meant (hat the effective interest rate became 4?4 percent. It also meant, of course, that nobody wanted a longterm bond that paid any less. Indeed, most bond dealers expected the price to continue falling, and the effective interest rate to rise accordingly.
They were confirmed in this view in early December when the government brought out $400 million worth of short and medium-term securities. The mediums were particularly attractive— four-year bonds with a special, unusual price guarantee, whereby the purchaser could cash them any time after two years for the issue price. These “twoby-fours," as the bond dealers called them, looked like a good buy in ordinary circumstances, yet hardly anyone bought them. The issue is still mainly in the hands of the bond dealers and the chartered banks.
John Meyer, financial editor of the conservative Montreal Gazette, said in a signed column that this indifference “points to a disturbing conclusion: the bond buyer no longer has any confidence in the government ... in their preference for corporation bonds over government bonds, investors are saying in effect that they no longer have confidence in the government to redeem its commitments. The integrity of Canada's credit has never been questioned before as it is being questioned now.”
These strong words, in a newspaper as staunchly Conservative and as close to the captains of Canadian finance as the Gazette, raised a considerable stir in Ottawa. Government economists said Meyer was overstating the case, things weren’t really as bad as all that. Meyer himself wrote another column a week later, in a much more moderate tone. Nevertheless the impression persisted that his first column, titled “Crisis in Confidence,” truly set forth the general opinion of the financial community in Montreal and Toronto. And whether it is right or wrong, this opinion is devilishly influential.
For example, a prosperous family firm in Ottawa recently had some money to invest: the president suggested buying government bonds. “Don’t be silly,” said his financial adviser. They bought some corporate securities instead.
A Canadian bond dealer called a client in New York to see if he wanted some of a recent issue. “Count me out,” the New Yorker said. “You people have lost your fair-haired-boy status, as far as we are concerned.”
Of course this does not mean, and will not mean, that the Government of Canada can't raise the money to finance its deficit. The government is not an ordinary borrower. Whatever the public won’t lend, the government can “borrow” from its own Bank of Canada. But that kind of “loan” is pure inflation. the equivalent of simply printing more money.
Even the sale of government bonds to the private chartered banks is inflationary because it increases the money supply in the hands of the general public. And this kind of inflation we have already in Canada, well advanced.
Since the Diefenbaker government came to power in June 1957, the total amount of Canadian government securities outstanding has gone up by about $1.4 billion. None of this increase has remained in the hands of the general public. It is all held by the chartered banks, and by the Bank of Canada. The general public in mid-December held actually less — $156 million less — of government securities (except Canada savings bonds, which are guaranteed and are therefore almost the same as cash) than it held in June 1957.
Total increase in the money supply during the eighteen months has been $1.5 billion, about 14 percent. Produc-
tion has been going up too during 1958, but not that much—we already have a lot more money available to buy a little more goods. Prices have continued to rise all through the recession. If the government has to go on getting its $ 100-odd million a month of new money from the banks alone, or from the Bank of Canada, the inflationary pressure will be enormous.
Of course the government doesn't have to rely on the banks. The public will buy Canada bonds if the price is right—i.e., if the interest rate is high enough. But how' high can the government afford to let the interest rate go?
The trouble is that nobody else can borrow as cheaply as the government does. If the government pays 43A percent (as it is now doing, with long-term bonds at their present price) then the province of Ontario has trouble selling its bonds at five percent. Other, less wealthy provinces have to pay more. Cities and towns, school boards and hospitals will pay still more—so much, in fact, that most of them won't be able to borrow at all.
Moreover, a rising interest rate means a falling price for the government bonds already issued. The chartered banks hold large amounts of these bonds, which they will want to sell if demand picks up for commercial loans — but they won’t want to sell at a heavy loss. Neither will the thousands of individuals, the elderly folk, the proverbial widows and orphans, who have put their life's savings into government bonds and who may want to cash them. From all these will come heavy pressure on the Bank of Canada, through its owner the government, to buy whatever government bonds are offered and keep the price up. But this in turn would multiply the inflationary pressure, and that is the government's dilemma.
Let’s not exaggerate. Nobody thinks the Canadian dollar is going the way of the Chinese in the 1940s, or the German mark in the 1920s. Nor does any sensible person imagine that government bonds will become worthless, or interest rates go sky high. But even a little more inflation, or a little more sag in the bond market, or both, could be quite serious in a land as used to stability and prosperity as Canada.
These evils look alarmingly likely unless the deficit is somehow reduced— and that looks alarmingly unlikely.
The impression in Ottawa is that Finance Minister Fleming himself is very much aware of the perils ahead, but that he has not been able so far to convince his colleagues, including the prime minister. Normally the minister of finance is closer to the prime minister than any other colleague, and has a kind of veto power on the spending plans of all other departments. Fleming docs not seem to have this status in the Diefenbaker cabinet.
Also, the alternatives are uniquely difficult. Never before in history has Canada faced a problem of inflation and unemployment at the same time. Nobody quite knows how to deal with it. and even the hardiest of the "sound money” men concede that a balanced budget in the coming year is out of the question.
What they do demand is some kind of gesture, some sign that the inflation danger is at least recognized, and that a balanced budget can be achieved eventually. They may get it. If not, there may well be a rash of resignations among senior people that the government won’t be able to explain away. ★
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