Bank Assets As a Percentage of GDP

And you thought the American banks were too big to fail!

Canadian banks, bailed out by the Fed.

Documents released by the Federal Reserve show that Canadian banks used the Fed’s special loan programs to strengthen themselves when the economy started to go sour.

I find this very enlightening. First of all, there is stubborn myth that circulates our country, averring that Canadian institutions did not need a bailout. This is simply untrue. Canada’s bank bailout was a little more sophisticated, a little less blatant, than, say, the US bank bailouts, but it amounted to a bailout nonetheless. The Canadian government buffered its big financial institutions with a whopping $75 billion dollars used to buy bad assets.

Second, the Fed’s loan programs are bailouts too.

Canadian banks said the moves to seek loans from the Fed were dictated by strategy and not by necessity.

RBC accessed funding from the Fed “purely for business reasons – better pricing and collateral rules – and because they were the best deal for our shareholders at the time,” said Gillian McArdle, a bank spokesperson. “Our access to funding remained very strong through the entire crisis.”

This is an interesting thing to say. Let us think about this a bit.

Remember that the Federal Reserve has a monopoly on the creation of US dollars. It can buy any asset it wants with digital dollars created out of nothing. Other institutions cannot do anything like this.

If an institution like Royal Bank cannot raise capital on the market and turns to a central bank for help, this is a bailout. This allows it to strengthen its balance sheet in a way that would not be possible without the central bank’s intervention. Saying this does not amount to a bailout is incoherent.

Central banks exist to bail out big financial institutions and governments when markets go bad. In 2008, the Fed bought a trillion dollars or so in garbage assets that the market would not touch at face value. The Bank of Canada helped bailout banks too.

So in addition to getting bailed out by the the BoC and the Canadian government, Canadian banks were bailed out by the Federal Reserve as well!

Why is this important? In the business cycle, when the boom period reaches its apex and market forces begin initiating vengeful corrections, bad debts must be liquidated for the economy to become rebalanced. This is value of the recession — it restores soundness to the economic system by clearing out the malinvestments perpetuated by expansionary monetary policies that create the bubble. Of course, in 2008 governments and central bankers around the world stepped in to ensure that would not happen.

The fact that Canadian institutions availed themselves of the Fed’s interventionary loan programs (to say nothing of the $75 billion bailout from Canada) reveals that Canadian banks are not as strong as people claim. Like all commercial banks operating on fractional reserve banking systems, Canadian banks are inherently on the verge of bankruptcy at all times. Our system ought not be the envy of the world — instead, it is just another facet of the nightmarish system that Bank of England Governor Mervyn King candidly called “the worst banking system conceivable.”

Jim Rogers, Andrew Schiff, and some economic ignoramus named Doug Henwood talk about TBTF and taxes.

Listening to this Doug Henwood fellow on taxes is truly unbearable. Have fun.

This is an entertaining discussion but it is pretty boisterous and a lot of cogent points get lost. The group talks about the Too Big To Fail policy as “socialism for the rich,” which is a legitimate given the policy of bailing out big, insolvent financial institutions. There is no dispute with any of this.

Socialism for the rich should be rejected, but Schiff makes a valid point that, insofar as bailing out financial institutions was intended to keep credit flowing liberally to borrowers whose credit-worthiness was otherwise inadequate, the TBTF policy was “socialism for the poor” as well. American consumers are addicted to debt and low interest rates.

Rogers and Schiff are apparently opposed to socialism in principle, but Henwood is only against “socialism for the rich.” He likes other forms of economic interference, such as that which distorts interest rates, or that which taxes the rich.

Henwood thinks it is perfectly justified to say that higher taxes can possibly help economic growth. This is untrue, and the economic case against it is probably irrefutable. I will summarize:

If economic actors exchange property voluntarily, then it is implied that both actors are better off than they would be in absence of this trade. If both did not expect to benefit from the trade, they would not take part. The matter is quite different in the case of taxation. With taxation, the producer’s supply of goods is reduced against his will to a level below what it would be absent the taxation. In addition to this reduction of present goods, the supply of future goods is reduced as well. For taxation is not unsystematic and random, but systematic and expected to continue in one form or another. Therefore, it implies a reduced rate of return on investment and produces an added incentive to engage in fewer acts of production in the future than one otherwise would. Overall incentive to be a taxpayer decreases, and incentive to become a tax-consumer increases.

This is always true. But Mr. Henwood would disregard economic science and make his inferences based on a shallow analysis of empirical data. Of the US, he says the Clinton years saw a period of great economic growth, and tax rates were higher than they are now. So, he infers, higher tax rates contribute to economic growth.

This doesn’t make any sense. If Henwood were an economist, I would call him a crank. But he is not an economist, he is an English major. He does not have a background in economics, but he likes to write about it. There is no evidence that he is capable of applying formal theory to reality and interpreting it.

In addition to being completely fallacious, the above argument for higher taxes is only credible on the most superficial analysis. If Austrian business cycle theory is correct, then one could easily argue that the much-heralded ‘growth’ of the Clinton years was just phony wealth created by economic bubbles brought about by artificially low interest rates.

When Reagan was elected in 1980, short-term rates were 11.4 percent. When Bush I lost to Clinton in 1992, the rate was 3.4 percent. Rates moves upwards over the course of the Clinton years, and in 2000 the average Treasury bill rate was 5.8. The manipulation of interest rates created economic dislocations — the dot-com bubble, among other things — and the inevitable crash.

Doug Henwood doesn’t know what he is talking about.

%d bloggers like this: