FYI - Paul Hellyer was a former Deputy Prime Minister of Canada

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Subject:  [ERAInf] Economics for Boomers -- Paul Hellyer
Date:  Wed, 28 Jan 2004 23:07:21 +1030
From:  ERA <>
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Economic Reform Australia
ERA Information Network

Date: Thursday 29 January, 2004
Source: COMER Web Site (accessed January 28, 2004)
Organisation: The Committee on Monetary and Economic Reform

Economics for Boomers
by Paul Hellyer

It takes a certain amount of chutzpah to tell a whole generation of boomers that they have been mis-educated but if you have studied economics under a mainline professor any time since the mid-1970s the odds are 20 to 1 that you have been. You have probably been taught that Keynesianism was bad and Friedmanism is good and that as a result of the switch from one to the other we now live in an age of enlightenment.

To believe this, of course, is to ignore the data. Since the Bank of Canada adopted monetarism and the ideas of Milton Friedman in 1974, in concert with other central banks, Canada's economic performance, along with that of most of the world, has been very bad.

Neo-Classical Economics - A Dismal Failure

If you compare the years 1949-1973 with the period 1974-1998 - the twenty-five years since Friedmanism was adopted by central banks - you will see the dismal results. The average increase in GDP dropped 43% from 4.9% to 2.8 percent. Unemployment increased by 90% from an average of 4.74% to almost 9 percent. All of this resulted in a monumental 2,289% increase in federal debt.

The increase in debt was not primarily due to overspending as the right insists. It was primarily due to the slow growth of the economy and debt compounding at high interest rates due to monetarist policies. Compound interest was the real culprit.

The data for Australia, and even the United States, are almost as bad. But world figures are the most shocking. From 1950 to 1973, the average compound growth rate of per capita GDP was 2.9 percent. From 1973 to 1995, it was down to a disastrous 1.1% - more than a 50% reduction.

So, when you see pictures of undernourished children, or read about the millions who cannot afford to go to school, or even see the homeless people in Montréal and Toronto, there is a reason for these tragedies. They are due in large part to bad economic theory and bad economic management.

You have to ask where the writers who talk about "the unquestioned benefits of globalization" get their information. Based on the data, one is forced to conclude they write fiction instead of fact. Or that they are looking only at corporate profits and ignoring all else.

The data demonstrates clearly that Friedmanism has grievously harmed the public interest. And there are reasons for it. The Nobel laureate misdiagnosed the inflation of the late 1960s and early 1970s as classic inflation, i.e. too much money chasing too few goods. He was almost 100 percent wrong in this diagnosis. The inflation of the late '60s and early '70s was caused by the exercise of monopoly power by big government, big business and big labour. Labour demanded and was granted wage increases far in excess of productivity. So costs rose followed by prices.

The wage-price spiral became a vicious cycle, like a dog chasing its tail. Central banks were put in the invidious position of either allowing the money supply to grow fast enough to clear the market at the new higher prices, with rampant inflation, or of compromising and creating massive inflation and unacceptably high unemployment at the same time. We called it stagflation.

The only other significant inflation in those years was the increase in oil and energy prices due to the exercise of monopoly power by the Oil Producing and Exporting Countries (OPEC). The supply of oil was arbitrarily limited so the price rose. But the blip caused by energy prices was never more than a small fraction of the total inflation which was primarily due to the wage-price spiral.

Cure Worse Than Disease

Having misdiagnosed the inflation of the period as classic rather than primarily cost-push it is not surprising that Friedmanites prescribed the wrong cure. They induced two dreadful recessions first in 1981-82 and a decade later in 1990-91. The result was comparable to using an atomic bomb to do a job better suited to a sniper.

The social damage was incalculable, and will not be elaborated here. Less well appreciated is the fact that the economic damage was incalculable, too, and lasts to this day. The 1981-82 recession, the worst since the Great Depression of the 1930s, was the genesis of today's world debt problem.

Economies were slowed by restricting the money supply, government revenues fell and deficits increased. These were rolled over into debt and compounded at high interest rates. Boomers will find it hard to believe that less than 5% of Canada's federal debt is due to program spending while the other 95% resulted from compound interest due directly to the neo-classical monetarist practices they were taught with near religious zeal.

In the early post-war years debt grew at approximately the same rate as the economy because interest rates were kept low - comparable to the growth rate of the economy. Consequently the compound growth rate of one was roughly equal to the compound growth rate of the other which meant that the debt to GDP ratio was almost constant for decades. All of that ended with the 1980-81 recession when debt to GDP curves headed for the sky.

Pre-Depression System

When monetarism proved to be technically deficient, most mainline economists dropped the word in favour of neo-classical economics. It should be called retro-classical rather than neo-classical, because it is not new. It is the same old pre-depression system which gave us the boom of 1928, the crash of 1929 and ten years of social and economic misery in the 1930s until the advent of war bailed us out.

It is the system that gave us 44 recessions and depressions in 200 years and is setting us up for another one. The only reason the system hasn't crashed already - because the total level of debt world-wide is unsustainable - is because the International Monetary Fund has been using taxpayers money to lend to Third World countries so they will be able to pay the interest on existing debt and make the loans appear to be performing when in fact they are non-performing.

Meanwhile the principal amount of debt of Third World and developing countries continues to rise. It rose about $200 billion in 1997 and 1998 so the principal benefit of the IMF bailouts is to maintain the "feel good" atmosphere which has been sustaining the advanced economies.

Micro Efficiency - Macro Madness

If there is one characteristic of globalized investment it is the large corporate fish swallowing the smaller ones. This began inside individual countries but as the feeding stocks were depleted the big fish had to move to other peoples pools to maintain the feeding frenzy.

You can make a case for mergers and take-overs on the basis that the same output of goods and services can be achieved with less human input. Consequently bigger companies may be "efficient". The same amount of work accomplished with fewer people.

There are some caveats that have to be entered, however, in order to get the whole picture. If the work-force is reduced to the point where those who remain are stressed out to the extent that they have no outside life the human dimension is lost. In some cases the stress leads to illness and the taxpayers pick up the tab.

Then there is a presumption in classical theory that those long-time employees who have been displaced will find other equally well-paying jobs. In the real world this is seldom the case. Too often they are too old, or their skills are not required, so they wind up in a low-paying jobs where their income is inadequate to maintain a reasonable life-style.

If the savings from the mergers and acquisitions were passed on to consumers that would
help offset the lower wages of the displaced. But they are not. What we are seeing in the world today is not the smooth functioning of a competitive market system, which is fundamental to Adam Smith's notion of the "invisible hand", it is a frantic scramble to achieve monopoly (oligopoly) power.

Today we are seeing an extension to the world stage of the American experience in the late 19th century when the Rockefellers, Mellons, Carnegies and Morgans gobbled up the competition in fine style. Their aim was to prevent competition, not encourage it. The new world order is doing the same thing globally. A few companies in each industry are attempting to dominate world markets, eliminate competition and keep prices and profits high.

Economics Void of Morality

The giant companies are emerging as the world's absolute monarchs, making life and death decisions for millions. They tell governments what taxes they can impose and what laws they can pass. A combination of low taxes and high prices guarantees that the benefits trickle up for the benefit of the officers, directors and principal shareholders of the companies. There is precious little, if any, trickle down to the population at large which might be expected in an era of such extravagant opulence in the developed world.

Corporate rule is supplanting democracy in world governance. Little wonder that the Hungarian-born American financier George Soros has concluded that: "Unfettered capitalism has replaced communism and fascism as the greatest threat to open societies."

Neither Keynes Nor Friedman Will Do

While the last quarter of the 20th century was an unmitigated disaster compared to the "golden years" of the '50s and early '60s, neither Keynes nor Friedman hold the key to a sane, stable and sustainable economic system. Neither offers a solution to the absolutely fundamental question of how new money is created and put into circulation.

It is unquestionably the most poorly understood aspect of economics. One of the most devastating consequences of the "monetarist counter-revolution" was to return to the privately- owned banks the virtual monopoly to "print" money which they had enjoyed prior to World War II. This was a major contributor to the rapid increase in debt due to compound interest.

When World War II broke out central banks, including the Bank of Canada, began printing money and making it available to governments at low cost. The Bank of Canada printed money to buy Government of Canada bonds. The government paid the Bank of Canada interest on the bonds. This was repaid to the government as dividends - only the cost of administration deducted. So the net cost was near zero.

The government spent the newly minted money into circulation and it wound up in the private banks where it became what economists called "high-powered money." In effect, it became the monetary base which allowed the private banks to expand their "credit money" creation to help finance new factories, make loans to people wanting to buy war bonds, etc.

From 1939 to 1974 the money creation function was shared between the government of Canada (through the Bank of Canada) and the private banks. This was the system that got us out of the Great Depression, helped finance World War II, helped finance the post-war infrastructure, including the St. Lawrence Seaway, the Trans Canada Highway and the great new airports while at the same time laying the foundation for our social security net. It was the system that gave us the best 25 years of the twentieth century.

In 1974 the Bank of Canada owned more than 20% of federal government debt which was the equivalent of an interest free loan. That year, however, everything changed. The Bank of Canada adopted the ideas of Milton Friedman and it has been downhill ever since. Instead of buying its share of government bonds it bribed foreigners to buy - coaxed with high interest rates - the bonds it didn't buy. That's how we got so deeply in debt to foreigners while the high interest rates kept compounding our total indebtedness.

The current system is not only expensive, it is unsustainable. Federal debt is now being paid down a bit but total debt continues to rise. Last year the indebtedness of the average Canadian family rose to 100% of after tax income for the first time in history. Obviously this cannot continue without putting the stability of the entire economy at risk.

There is only one solution that will achieve sustainability. Canada must return to the system in effect between 1939 and 1974. Only with access to significant sums of government-created money (GCM) will Canada have the fiscal flexibility to increase expenditures for social and other services on the one hand, while reducing taxes and paying down the federal and provincial debts at a reasonable pace on the other hand.

We recommend that about one-third of the new money created each year be GCM. This would give the federal government an additional $10 billion a year for the purposes stated above. This could only be done, of course, if the Bank Act were amended to require banks and other deposit-taking institutions to maintain cash reserves against their deposits.

Creating Jobs

One final myth from the Freidmanites. They claim that governments don't create jobs, only private markets do. This is patent nonsense. Whenever anyone spends money on goods and services jobs are created and it doesn't matter whether it is government, industry or individuals.

When governments repair or build roads, replace or build sewers, clean up riverbeds, spend more money on research or product safety certification, hire more doctors and nurses or spend more money on the arts or the armed forces jobs are created. Similarly when industry expands or builds new factories, or when individuals buy new houses, new furniture, new clothes, new cars, or repair old ones, jobs are created.

And contrary to widely held opinion, tax cuts may or may not create new jobs. It depends entirely on who gets the money and what they do with it. If it is used to pay down debt no new jobs are created; if it is used to finance a holiday in France or the U.S., jobs will be created there, but not in Canada; if it is invested in the stock market to bid up stock prices, it will not create new jobs. It is only when it goes to companies or individuals who spend it on goods and services that new jobs are created.

Premier Mike Harris has claimed that his tax cuts were responsible for the impressive number of new jobs created in the Ontario economy in the last two or three years. This is a gross exaggeration. Increased exports has helped, but the most significant factor has been lower interest rates. When money is cheap business will take on debt to expand, and individuals will borrow more for houses, cars, computers and furniture. That's when the economy expands.

In summary, neither the ideas of Keynes nor Freidman are adequate to the needs of the 21st century. We must draw from the best ideas of the economic world and add new, innovative extensions necessary to turn the old boom-bust and high debt system into something more efficient, more moral and more sustainable.

The Hon Paul Hellyer was formerly deputy prime minister of Canada, and is currently leader of the Canadian Action Party. He has written several books dealing with economic reform issues.

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