Ken Boessenkool: Money's not for nothing
The Bank of Canada has been floating our debt. This might be a bad idea at the worst possible time.
“Money for Nothing” by Dire Straits is layer upon layer of irony. Musician Mark Knopfler cribbed the lyrics from an appliance delivery man who was watching music videos and complaining about the posh life of rock stars. Layer one of irony is that Knopfler used those words to create Dire Straits’ biggest money-making hit. Layer two is that the music video for “Money for Nothing” was a huge contributor to the band’s success — it won numerous awards and was the first music video shown on MTV Europe. Of course, the hit was based on the enormous guitar talents of Knopfler, the band and a cameo appearance by Sting.
It was, in fact, money for something.
I was reminded of all of this when I saw a tweet on monetary policy and the Bank of Canada by emerging Canadian economic star Frances Donald.
No really, hear me out.
Donald pointed out that the Bank of Canada bought about 80 per cent of the debt racked up by the Canadian government since the onset of COVID in March. She then pointed out that by the end of 2021 the Bank of Canada is projected to hold well over half — 60 per cent — of our national debt.
This is long overdue according to the Money for Nothing crowd — a collection of economists proposing something called Modern Monetary Theory (MMT). They argue that our central banks should just buy up all government debt to allow our governments to spend freely, or much more freely.
These economists remind me of the appliance delivery man. There is, or seems to be, just enough truth in what they are saying to be believable. Just enough truth to make governments think they can spend with impunity because the bank is giving them money for nothing.
And in fact, central banks around the world have been printing money — which is what this practice amounts to — to protect their populations. The U.S. government engaged in a massive amount of this activity after the 2008 financial crisis and that all seemed to work out fine. As the debt held by the central bank expired, buyers appeared to take this debt off their hands. And when the buyers didn’t materialize, the Federal Reserve refinanced it by printing another batch of money.
So we’re fine, right? Money for nothing, and your cheques for free.
First, the government debt bought by the Bank of Canada will expire. It is all of relatively short duration. And when it expires the bank can sit back and relax as private markets scoop up the debt. Easy peasy, right? The Federal Reserve did this, right?
Not so fast. We are not the United States. The Canadian dollar and the Canadian economy is not a global reserve currency. We don’t have access to the global investment the U.S. does. And worse, nearly every other developed country’s central bank will be floating expired government debt at exactly the same time. The sheer amount of debt refinancing that markets will be asked to refinance in the coming year will be immense, gargantuan, stupendous. And markets get to chose whether to buy American, German, British, French, Canadian, Italian or Greek debt.
Yeah, in about that order.
So what happens if the only way Canada’s expired debt gets scooped up is if our bonds get discounted — or to put it another way, what if the only way this debt can be refinanced is at a higher interest rate?
Now I’m not saying this is going to happen. A critical reason why racking up debt to deal with COVID is the right thing to do is that interest rates are at historic lows. Even with all the new debt racked up since March, the interest costs on our national debt will be lower this year than last year.
But the past is not always the best predictor of the future. What if the markets demand a premium to buy Canada’s expired debt now held by the Bank of Canada? What if markets prefer to buy American, German, British and French bonds, but then decide they need an extra premium to buy Canadian bonds?
This extra premium will put upward pressure on Canadian interest rates right smack dab in the middle of the recovery. So it won’t be money for nothing. It will be money for something, and that something is very damaging upward pressure on Canadian interest rates.
Which leads to the second and much more serious “Money for Nothing” irony. Which is the sudden and enormous pressure that will be on the bank to just buy this debt again to keep interest rates from rising and the economy from contracting.
And where will the pressure to do this be the strongest? From the prime minister and the minister of finance who will be managing the recovery, or worse, managing an economy veering its way into another coma due to a second wave.
One of the foundational aspects of our economic system — indeed the economic system of every developed country — is the independence of the central bank. Central banks need to be able to focus on a singular goal — keeping the value of our currency stable by controlling inflation — without political interference. Aside from setting the mandate or target, the government of the day simply must allow the central bank to do this work unimpeded.
That independence will come under threat if the government needs to continue deficit spending (which we may have to do for a spell yet) and the cheapest way to do that is to get the central bank to keep buying its debt. This would risk a devaluation of our currency, which will increase the prices of imported goods. Every Canadian would feel this devaluation every time they go grocery shopping, pick up a new pair of jeans, or try to buy something on Amazon. The incomes remain stagnant, but everything we want to buy with them becomes more expensive.
Once again, it will be money for something. And that something is the loss of central bank independence that will lead to the loss of the Bank of Canada’s ability to focus on one thing — keeping the value of our money stable by controlling inflation.
I’m not here to say any of these things will happen. I’m here to say that they could.
Dire Straits built their success on irony. Money for nothing was in fact money for something.
Well worth remembering when the Money for Nothing economist crowd shows up.
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